The escalating conflict in the Middle East has presented a new challenge for central banks worldwide, with the potential oil shock and subsequent inflation risks adding complexity to policymakers' growth strategies.
The recent strikes by the U.S. and Israel on Iran, resulting in the death of Supreme Leader Ali Hosseini Khamenei, have sent crude prices soaring. Tehran's retaliatory missile attacks on multiple Gulf countries have effectively halted tanker traffic through the Strait of Hormuz, a critical chokepoint for global oil shipments.
Brent crude prices have risen to their highest levels since January 2025, with a four-day gain of 1.6% to $82.76 per barrel. U.S. West Texas Intermediate crude prices also increased for a third consecutive day, reaching $75.48.
This surge in energy prices will inevitably impact consumer and producer prices, particularly for economies heavily reliant on Middle Eastern oil imports. Central banks are now faced with the daunting task of reassessing their interest rate trajectories.
"The ongoing Iran conflict strengthens the case for many central banks to maintain steady rates for the time being," commented a team of economists from Nomura.
Central banks are on high alert, navigating the delicate balance between managing inflationary risks and addressing slowing economic growth. The European Central Bank, in particular, finds itself in a "genuine dilemma," as an oil shock could exacerbate already high inflation while its growth outlook weakens under the pressure of increased U.S. tariffs.
Europe, which imports nearly all its oil and a significant portion of its liquefied natural gas, faces the dual threat of an energy and trade shock. ECB council member Pierre Wunsch emphasized the need for careful consideration, stating that officials would avoid hasty reactions to energy price movements.
Former U.S. Treasury Secretary Janet Yellen warned that the conflict could impact U.S. economic growth and fuel inflationary pressures, potentially hindering the Federal Reserve's ability to cut rates.
U.S. inflation stood at 2.4% in January, above the Fed's 2% target. Yellen cautioned that President Donald Trump's tariffs could push annual inflation to at least 3%.
This latest escalation follows Trump's seizure of oil-rich Venezuela earlier this year and his threat to take control of Greenland, another strategic energy reserve. Brent crude has risen by 36% so far this year, while WTI futures have increased by 32% as of Wednesday.
The global energy market is grappling with a worst-case scenario, with a prolonged disruption in the Strait potentially pushing Brent oil prices above $100 per barrel and European natural gas prices surpassing 60 euros ($70.17) per megawatt hour, according to Bank of America.
Asian economies are particularly vulnerable, as most crude shipped through the Strait of Hormuz flows to China, India, Japan, and South Korea. Under the assumption of a six-week closure of the Strait and a jump in oil prices from $70 to $85 per barrel, regional inflation in Asia could rise by approximately 0.7 percentage points, according to Goldman Sachs.
The Philippines and Thailand are expected to be the most affected, while China may experience a more moderate increase. Central banks in Asia, such as those in the Philippines and Indonesia, may pause rate cuts, while policymakers in India and South Korea are likely to maintain steady rates for an extended period.
BMI, a unit of Fitch Solutions, estimates that the conflict will add seven to 27 basis points to headline consumer inflation across Asia, with the sharpest impact in Thailand, South Korea, and Singapore due to the higher weightage of energy in their inflation calculations.
"For a 10% oil shock, the inflation addition is small enough that most are likely to look through it. However, the calculus changes significantly with $20–30 per barrel increases, where headline CPI impacts double or triple, and second-round effects become harder to ignore," the research firm noted.
Nomura expects Malaysia, Australia, and Singapore to tighten interest rates, while the bank has lowered its expectations for a rate hike by the Philippine central bank. The bank also anticipates a modest 0.01-percentage-point impact from higher oil prices on Singapore's GDP growth.
Indonesia and Singapore have stated that they are closely monitoring financial markets, with Bank Indonesia committed to keeping the rupiah in line with economic fundamentals and the Monetary Authority of Singapore assessing the conflict's impact on the domestic economy and financial system.
Fiscal stimulus and subsidies could help mitigate some of the inflationary impact, providing a relatively comfortable starting point heading into 2026.
"We expect Asia to utilize fiscal policy as the primary defense mechanism to protect consumers," said Nomura economists. Possible measures include price controls, increased subsidies, fuel excise tax cuts, and lower import tariffs on crude oil and refined products.
However, these subsidies could strain governments' already tight fiscal budget deficits, as noted by Rob Subbaraman, head of global macro research at Nomura.
"So which 'negative' do you want to have: higher inflation or worse fiscal? These are the policy choices governments must grapple with."
The Middle East conflict and its impact on global energy markets present a complex and challenging scenario for central banks and policymakers worldwide, with potential implications for economic growth and inflation.
