Inflation
The primary transmission mechanism of this conflict is cost-push inflation. With crude oil and liquefied natural gas (LNG) supplies under threat, energy costs have spiked globally. In the United States, gasoline prices have climbed toward $4.25 per gallon, pushing Consumer Price Index (CPI) projections toward 3.5% for the summer of 2026—a level that is substantially above the Federal Reserve’s 2.0% target.
The Eurozone and the UK are facing a severe stagflationary threat as high energy costs mean inflation is being imported directly. This has forced the European Central Bank (ECB) to revise its 2026 inflation forecast upward to 2.6% (from 1.9% pre-conflict) and the Bank of England (BOE) to signal that inflation will remain significantly higher than previously expected, with recent market revisions pushing projections toward 4.0% (up from 2.5% previously).
Japan faces similar risks. As a major energy importer it is particularly exposed to the ramifications of the Persian Gulf conflict. The OECD consensus for Japanese inflation stands at 2.4% for 2026, while recent economist polls show core CPI being revised upward by 0.2–0.4 percentage points across several quarters due to the direct pass-through of rising energy costs.
Central Bank Response
‘Before the conflict, the market theme for 2026 was a pivot toward lower interest rates, but the war has effectively paused that narrative’, says Kar Yong Ang, a financial market expert at Elev8 broker, adding that high oil prices effectively act as a tax on consumers, destroying aggregate demand within the economy. Normally, when demand falls, central banks would cut rates, but presently they are unable to do so while energy-driven inflation remains unanchored.
Current market pricing reflects this global hawkishness, with the Fed now expected to keep rates unchanged at least until March 2027, while the ECB, BOE, and BOJ all face roughly even odds for 25-basis point hikes as early as June. For traders, this synchronized shift toward ‘higher for longer’ rates across the G7 countries underscores a fundamental change in the global macroeconomic landscape.
The Federal Reserve
Although the U.S. Gross Domestic Product (GDP) forecast for 2026 has been trimmed only modestly to around 2.3% (reflecting energy-cost drag on consumption and investment), market monetary policy expectations have shifted dramatically. The latest interest rate swap data indicates a less than 20% chance of even a single 25-basis point cut from the Fed this year, representing a sharp change from the three cuts previously anticipated. However, Fed minutes show some officials worry that a prolonged conflict could trigger stagflation (higher prices plus weaker growth), which potentially opens the door to extra cuts later if labour markets soften.