Five major central banks—the US Federal Reserve, the European Central Bank, the Bank of England, the Reserve Bank of Australia, and the Bank of Japan—met this week to deliver their rate decisions. Four of the five opted to pause and continue with existing policy rates. Two smaller countries—Sweden and Switzerland—also opted to pause.
Given the economic chaos unleashed by the US-Iran war, this was not a surprise. But it is a complete turnaround from the start of the year when, as ECB president Christine Lagarde put it, monetary policy was “in a good place”. As recently as one month ago, the UK was expected to cut rates; there was a decent chance the US Fed would cut rates, too; and Japan was on a rate-hike cycle. But the closure of the Strait of Hormuz as the war escalated has forced authorities to abandon previous policy paths and adopt a wait-and-watch approach.
Geopolitical uncertainty
The world has lurched from one crisis to another in recent years: a global pandemic (2020), galloping inflation following the Russia-Ukraine war (2022), the Israel-Hamas conflict (2023), the tariff war (2025), and the US-Israel invasion of Iran (2026).
The current level of geopolitical uncertainty is comparable to the worst crises of this century for two reasons. First, some of these shocks have persisted (since the Ukraine war), and all of them have accumulated to create a high level of geopolitical tension. Second, the old rules-based world order with the US as the hegemon, backed by allies in Europe and Asia, is seemingly changing to a multi-polar world in which each country wrangles the best deals for itself. In this uncharted terrain, policymakers’ ability to predict future trends will be severely tested.
Previous crises had some obvious policy fixes. For instance, given the job and income losses during the pandemic, monetary easing and fiscal support were the most common and appropriate responses. Inflation following the Ukraine war was countered by monetary tightening worldwide. The current situation is unprecedented: the International Energy Authority (IEA) has called it the greatest supply disruption in the history of oil, and it is impossible to predict its extent or duration. Even by central bank standards, the level of uncertainty is too high to take a call on the future direction of rates.
Stagflation risk
The price of oil is now consistently above $100 per barrel. If oil stays there or increases further over a prolonged period, it will push inflation up and bring growth down significantly. This situation of high inflation and low growth—or stagflation—cannot be managed through monetary policy tools. An attempt to raise rates to manage inflation will dampen growth even more, and cutting rates to stimulate growth could increase inflation.
Right now, risks to inflation and growth vary depending on a country’s exposure to the West Asia crisis. The direct impact in terms of oil and gas supplies is the least for the US, which is a major energy producer; it is somewhat higher for the UK and Europe, which import a bulk of their oil and gas from the US and Norway. Japan is the most vulnerable as it depends heavily on West Asian oil. However, the indirect impact of higher global oil prices will be felt across sectors and nations, irrespective of their oil sources.
Crude is the bedrock of modern economies: its uses range from fuel to feedstock for a wide swathe of products. Rising oil prices will ultimately be passed on to products ranging from food to fertilizers to plastics. The Iran conflict is playing out at a time when inflation is above the 2% target in the US and the UK, and barely on target in Europe, making it tough to cut rates. As for Japan, given the downside risks to growth, raising rates could risk its fragile growth.
High debt
Developed countries’ sovereign debt is at an all-time high, partly due to pandemic-era fiscal handouts and partly because geopolitical tensions have pushed up defence spending. By 2030, the International Monetary Fund (IMF) predicts that Japan’s debt-to-gross domestic product (GDP) ratio will be at 227%, while that for the US will be at 129%.
This huge load of government debt could worsen with monetary tightening. Since most central banks have inflation targeting mandates, rate hikes are inevitable if the conflict is prolonged. Markets are already factoring in rate increases: a Reuters survey on 19 March showed that traders expect two rate hikes from the ECB and one hike from the Bank of England by year-end, while the probability of a rate cut by the US Fed has come down considerably.
As the rate increases pass through the system, long-term government yields rise too, increasing the interest burden on an already overburdened fiscal situation, and leading to greater indebtedness. There are a couple of ways to break this vicious cycle. One, higher economic growth can reduce the debt-GDP ratio by increasing the denominator. Two, if the growth rate is higher than the interest rate, debt is not likely to become unsustainable. Unfortunately, the present crisis has no good news on either front at this point, leaving monetary policy to pause and wait for more information.
India impact
The West Asian conflict has the potential to deliver simultaneous shocks to inflation, growth, and remittances from Gulf nations, just as RBI has neared the end of its rate-easing cycle. Currently, rates are paused, and the monetary stance is neutral. Unfortunately, every macroeconomic parameter will take a hit if the conflict is prolonged—the current account deficit will worsen, inflation will rise, and growth will stutter. Markets know this: that is why the benchmark 10-year yield has gone up by 100 basis points since the conflict began, and the rupee has depreciated from around 91 to 93 per dollar.
RBI’s monetary policy committee will face tough choices when it meets in April.
A rate cut could exacerbate foreign capital outflows, further pressuring the rupee. A rate hike would hurt growth, which is already under threat from tariffs and war. The most recent inflation print, at 3.2% in February, indicates that RBI has some space to hold rates and absorb inflation. On the other hand, rising Overnight Indexed Swap (OIS) suggest that markets may be factoring in rate hikes. The final decision will depend on how the war evolves. However, RBI has to be ready to respond flexibly to changing conditions.
The author is an independent writer in economics and finance.