With the flow of energy through the Middle East still mostly blocked and oil prices well above $100 a barrel, policymakers in Europe are confronting the immediate impact of already higher costs while trying to decipher the potential economic damage of a prolonged conflict.
On Thursday, the Bank of England held interest rates steady at 3.75 percent, as expected, but warned of a risk that higher inflation could spread through the economy. Officials at the European Central Bank also kept its main rate at 2 percent, adding that the affect depended on the “intensity and duration of the energy price shock.”
Investors are betting that the central banks will each raise rates several times later this year.
For the policymakers, hanging over the debates is the danger of stagflation, a troubling mix of stagnant economic growth and rapid inflation. Officials also worry that in raising rates to fight inflation, they could move too fast or too high and further stymie growth.
The closing of the Strait of Hormuz, a vital waterway for fuel off Iran’s southern coast, has sharply increased energy prices. Brent crude, the international benchmark, jumped on Thursday to its wartime high, while European natural gas prices are nearly 40 percent higher since the United States and Israel attacked Iran on Feb. 28.
“There is nothing monetary policy can do to prevent these cost increases from affecting U.K. businesses and households,” Andrew Bailey, the governor of the Bank of England, said at a news conference. “The longer the conflict in the Middle East continues, the worse the impact will become.”
The president of the European Central Bank, Christine Lagarde, said that “the economic outlook is highly uncertain.” But, she said, “the incoming information suggests that the conflict is weighing on economic activity.”
The war had an almost immediate impact on European inflation, increasing gasoline prices, airfares and other fuel-intensive activities.
In Britain, the annual inflation rate climbed to 3.3 percent in March and is expected to be around 3.5 percent at the end of the year, well above the central bank’s 2 percent target. For the 21 countries that use the euro, inflation averaged 3 percent in April, up from 1.9 percent in February, before the war, data published Thursday showed.
But for the central banks, the question is to what extent higher prices will ripple through the economy and push up wages, potentially setting off a spiral of escalating prices that would warrant aggressive rate increases like those in 2022. For now, analysts say there isn’t enough information on how the war, seemingly in a holding pattern, will affect the economy. While President Trump has extended a cease-fire in the region, traffic through the strait remains sparse.
At the same time, the concern about inflation is being weighed against signs that the war was already damaging economic growth. In that case, policymakers wouldn’t want to tighten financial conditions too much, because that could risk a recession.
Consumer sentiment in Germany, the eurozone’s largest economy, dropped to its lowest level in three years, data this week showed. Signs of strain in the region’s economy were starting to emerge. While there were differences among countries, the eurozone’s overall economic growth slowed at the start of the year. The bloc grew just 0.1 percent, compared with 0.2 percent at the end of last year, data published Thursday showed.
This month, the International Monetary Fund said the bloc’s economy would grow 1.1 percent this year, but that assumed a relatively quick resolution to the war and the recovery of global energy markets.
If the Strait of Hormuz stays closed for longer and oil prices climb to around $140 a barrel, Britain would face the risk of a recession and inflation of around 5 percent later this year, the National Institute of Economic and Social Research, a think tank, said this week.
Central banks around the world are confronting the same challenges. This week, the Bank of Japan voted to hold rates steady, but several officials preferred an increase. The central bank raised its inflation forecast while warning that economic growth is likely to slow this year.
On Wednesday, the Federal Reserve, holding rates steady, acknowledged the war’s effect on the economy, saying inflation had ticked up because of the “recent increase in global energy prices.”
The uncertainty sowed by the conflict has left policymakers grasping to explain the range of possibilities of what could happen next, and what they might mean for interest rates. Both the Bank of England and the European Central Bank have recently published several projections laying out different scenarios for energy prices and their potential impact on inflation for other goods and services.
On Thursday, Mr. Bailey at the Bank of England said the policymakers have to make “a difficult judgment call” in setting rates, because changes to policy can take awhile to have their desired effect. There were risks to waiting too long to act to contain inflation and, if the shock passes, moving too quickly.
Central bankers can’t wait for “conclusive evidence” one way or another, he said.
