We are two weeks in since war broke out in the Middle East and the past few weeks have been nothing short of a rollercoaster ride. ‘Disjointed’ is an understatement to explain the way global markets operate right now. The energy shock caused by the reduced operation of the Strait of Hormuz sends oil prices close to $120 on one day and following an X post by President Trump, it comes back down to the $90’s the day after. So much ambiguity around causing markets to sway in different directions as new information surfaces every day. Is the Strait of Hormuz operating at all? How much damage has the neighbouring Gulf nations faced? Are investors moving out? Will IEA’s 400 million barrels increase be enough to compensate for the reduction of oil supply?
As markets are pricing the heightened risk on oil, other commodities and capital flows, this week we find ourselves in a position where few major central banks are also to make their interest rate calls suggesting their outlook on the current context and how they see it impacting domestic economies. Policymakers are expected to price in the disruptions in global supply chains and the consequences to the domestic economy on one hand while factoring in the inflationary expectations that are building up as the war progresses on the other. Will they cut rates with the intention of giving a slight push to the domestic front? Will they hike to counter the expectations around inflation? Or, will they stay put and take a ‘wait and see’ stance? – questions that we’ll have answers to in the upcoming week.
Inflation signals, Job market and the Trump factor
The US Federal Reserve (FED) has maintained a cautious stance during recent months factoring in the inflation trends, labour market developments and risk conditions. At its first meeting of 2026, the US central bank left borrowing costs unchanged, following three consecutive rate cuts implemented late last year. Latest data on labour market front – The Bureau of Labour Statistics earlier this month reported that employers shed 92,000 positions in February as the unemployment rate rose to 4.4% from 4.3% - suggest that a rate cut seems to be on the cards to give a little boost to the slowing domestic economy. There is also the political push coming from the president who has repeatedly advocated for a cut. President Donald Trump demanded last Thursday that the Federal Reserve cut interest rates “immediately,” criticizing Jerome Powell for waiting until the central bank’s next policy meeting.
However, heightened inflation has been a key factor for the FED to not act out immediately. Price increases have remained stubbornly above the FED’s target rate of 2% with the latest data for February indicating 2.4% even BEFORE the Middle Eastern tensions came in to the picture. With visible effects of how US consumers and businesses are feeling the inflationary effects of the war now, analysts are pushing back the possibility of a rate cut to June 2026. The Federal Open Market Committee (FOMC) is expected to announce the next move on Wednesday (March 18th).
ECB facing the Eurozone test
While market expectations about a rate cut have drastically shifted since the war, whether or not the European Central Bank (ECB) may hike or keep rates unchanged is the conversation going on now. As a region heavily dependent on imported oil and natural gas, surging oil and gas prices has triggered an inflation shock for the ECB. The bank’s decision to resist despite market pressure to raise rates back in 2022 when Russia invaded Ukraine, did not serve the region well and could be a major driver of the rate call this time.
Growth expectations are also revised down with inflationary expectations picking up on the back of rising energy prices. Particularly on Germany, where economists predict a slowdown in growth as tensions continue which could impact the overall growth story of the eurozone. Yes, how long would the war last is a decisive factor to be considered here and a question that no one can give a proper answer to as of yet. What is certain however, is that the ECB is more likely to act faster this time in countering inflationary expectations at an early stage than in 2022.
Bank of England (BOE) also find themselves at a similar spot where expectations have reversed in a matter of days. Just two weeks ago, investors anticipated two quarter-point cuts in 2026, with the first coming as soon as the BoE’s meeting next Thursday. However, given the rising oil prices within the last few days with no signs of the war easing, investors are now betting on the BOE to raise borrowing rates.
Rate decisions across the rest of the world
Similarly, other major global central banks, including all members of the Group of Seven and those representing eight of the world’s ten most-traded currencies, are expected to signal to investors that the risk of a renewed inflation shock is significant enough to warrant a more cautious approach to monetary policy.
For instance. Japan, which relies quite heavily on imported fuel and food could face heavy stress if higher oil prices persist. Furthermore, prolonged weakness of the Yen – which fell on Friday to its lowest level against the dollar since 2024 - could also be a major concern that could quickly translate to domestic inflation and therefore a key area of focus in its interest rate decision.
Bank of Canada, Swiss National Bank, Reserve Bank of Australia, Swedish Central Bank and many other monetary authorities across the East and West are to re-visit their outlooks in the coming week.
What does this mean for Sri Lanka?
The most obvious point for Sri Lanka would be to see how global players are factoring in the possibility of the war being dragged on or not. If authorities are expecting a more prolonged ‘forever in war’ kind of scenario or if they expect this to be more short-lived with massive spikes in oil and other commodities in either way – up or down. As uncertainty, heightened energy prices and rising inflationary expectations are priced in, how investors move from there onwards will be key to look out for. While Sri Lanka’s relatively stable macroeconomic footing to face such crises unlike in previous episodes could present an opportunity to attract investors moving out of the Middle-Eastern region, a prolonged version of disrupted oil supplies undoubtedly, could cause serious damage which may alter the economic narrative both on the global and local front, for reasons beyond our control.