A war-driven spike in energy prices has increased the risk of central bank policy mistakes, with policymakers now facing a more difficult trade-off between inflation control and economic growth, according to T. Rowe Price.
T. Rowe Price CIO and head of global fixed income Arif Husain said the surge in energy prices had landed on top of already-elevated inflation pressures, leaving central banks vulnerable to missteps.
Husain said two types of policy error were now possible, with some central banks at risk of tightening policy when they should not, potentially stifling their economies, while others may instead look through the energy shock and risk allowing inflation expectations to rise.
He also warned that recent market moves may be sending a distorted signal to policymakers, arguing volatility had been amplified by technical factors rather than purely fundamentals.
“Recent market volatility has been driven in part by the unwinding of crowded and leveraged positions, combined with low liquidity, meaning price moves may not fully reflect underlying fundamentals and could complicate how policymakers interpret market signals,” he said.
That concern has also been echoed elsewhere, with GSFM investment specialist Stephen Miller warning higher oil prices could make central banks more focused on preventing inflation expectations from becoming unanchored.
“The sharp increase in the price of oil in the wake of the Iran conflict has ushered in a plethora of central bank warnings around the inflationary consequences of such an increase,” Miller said.
Miller said policymakers were keen to avoid repeating the mistakes of the 1970s oil shocks and argued the fading of long-running disinflationary forces, including globalisation and labour supply growth, could make today’s inflation backdrop more persistent.
“Bearing that in mind, and the abatement of structural inflation suppressants, it might mean that today’s world is more redolent of the 1970s and a surge in oil prices may have a longer lasting inflation impact.”
“That will mean that central banks have to be more attuned to the importance of anchoring inflation expectations than they may have during the three decades from the mid-1980s,” he said. “And that means a period of higher interest rates.”
Against that backdrop, Husain said the firm was seeing opportunities emerge across both currencies and rates as markets adjust to a wider range of policy outcomes.
In currencies, he said heightened volatility and shifting carry profiles were creating more differentiated return opportunities, while in rates, cross-market relative value and dispersion had moved to levels not seen since before the global financial crisis.
Husain said the recent strength in the US dollar should not be read as a return to its traditional role as a risk hedge.
“The recent US dollar strength has not been the result of its use as a risk hedge, rather it was driven by short positions being unwound and because oil is priced in U.S. dollars, suggesting the broader weaker dollar trend has not ended,” he said.
He added that after several years in which returns were largely driven by getting the direction of yields and curves right, the stronger opportunities now appeared to be in cross-market positions, with front-end rate differentials potentially improving risk and return outcomes.
Husain also stressed that the latest energy shock should be viewed in the context of an already fragile macro backdrop.
Before the war, inflation was already above target in many economies, the disinflationary impulse from China was fading, and US growth was expected to strengthen on the back of supportive policy, he said.
He added that uncertainty around AI’s effect on inflation remained unresolved, with possible near-term cost pressures offset by longer-term productivity gains.
As a result, Husain said the energy shock was not creating a new inflation problem in isolation, but intensifying pressures that were already building.