David McNamara: Central banks navigate Iran tensions
An overturned car sits on a section of a destroyed bridge after a strike in Hormozgan province, southern Iran on Saturday. The Middle East conflict, which has seen increased tensions and renewed hostilities, has had a significant impact on central banks as well as markets expectations, regarding their respective policy stances.
The Middle East conflict, which has seen increased tensions and renewed hostilities, has had a significant impact on central banks as well as markets expectations, regarding their respective policy stances. Most of the main central banks came into 2026 with a bias to either cut rates further or to maintain rates at low levels. Similarly, futures markets indicated that investors were anticipating further rate cuts over the course of this year.
Monetary policymakers were already operating in a volatile global macroeconomic environment amid the trade-related uncertainty that developed over the course of 2025, as the new US administration overhauled their trade policy with the introduction of tariffs. However, the war in Middle East has produced an energy price shock for the global economy which, in turn, has resulted in elevated inflation risks for central bankers to deal with.
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In the case of the European Central Bank, they decided to hike rates in June, by 25bps to 2.25%. Meanwhile, both the US Federal Reserve and Bank of England have paused their easing cycles, whilst at the same time, neither has ruled out raising rates. Against this backdrop, there has been a notable firming in market rate expectations, with pricing no longer reflecting rate cuts, but instead rate hikes during the second half of the year.
The market is very much leaning towards the prospect of higher rates between now and year end. From an ECB perspective, futures contracts are pricing in the deposit rate getting to at least 2.5% by December. In terms of the Bank of England, the market envisages the UK official rate rising from its current 3.75% level to 4.0%. Meanwhile, the market is expecting the Fed to raise rates back nearer to 4.0%, with rate expectations softening in recent days on the back of lower-than-expected Consumer Price Index (CPI) inflations numbers.
In terms of the actual evolution of official interest rates over the remainder of 2026, the direction of travel will be in a large part determined by developments in the Middle East conflict. A scenario in which tensions escalate further, oil prices see sustained increases again, and the limited progress in re-opening the Strait of Hormuz goes into reverse, would ramp up pressure on central banks to raise rates to meet their inflation targets.
However, if the recent ‘escalation’ is relatively contained and talks resume to find a long-term peace deal, including increased ship flows in the Strait, then the ‘tightening’ pressure on central banks may abate. In such a scenario where the conflict de-escalation becomes more sustained, attention could turn to when rates may start to fall again.
