The playbooks are useless now. After one hundred days of the Iran conflict and its cascading effects on global energy markets, the Federal Reserve and Bank of England find themselves in an uncomfortable position: they know what their mandates require, but they cannot confidently predict what their tools will actually accomplish.
Both central banks have adopted what can only be described as strategic paralysis — holding rates steady while issuing carefully hedged guidance that commits them to nothing. The reasoning is understandable. When oil prices swing fifteen percent on a single diplomatic tweet, when shipping insurance rates through the Strait of Hormuz change hourly, when defense spending surges across NATO economies, the standard models that translate policy rates into inflation forecasts become exercises in fiction.
The supply-shock dilemma returns
Central bankers spent the 2022-2023 inflation surge learning a painful lesson: monetary policy is a blunt instrument against supply-driven price increases. Raising rates can cool demand, but it cannot conjure oil tankers through a contested strait or rebuild semiconductor supply chains overnight. The Iran conflict has resurrected this dilemma in acute form.
The Fed faces a particularly awkward situation. Core inflation, stripped of energy and food, has remained relatively contained. But headline inflation — the number that appears on cable news and shapes consumer expectations — has lurched higher with each escalation in the Persian Gulf. Jerome Powell and his colleagues must decide whether to tighten policy to anchor expectations, risking a recession in an already fragile economy, or to wait out the geopolitical storm, risking that elevated prices become embedded in wage demands and business planning.
The Bank of England confronts similar arithmetic with additional complications. Sterling has weakened against the dollar as global capital seeks safety, pushing up import costs. British households, already squeezed by years of sluggish real wage growth, are watching energy bills climb again. Governor Andrew Bailey has signaled patience, but patience has limits when mortgage holders are renewing fixed-rate deals into a higher-rate environment.
Markets want certainty; policymakers have none
Financial markets have responded to central bank ambiguity with their own form of confusion. Rate futures now price in scenarios ranging from emergency cuts to support growth through additional hikes to combat inflation — sometimes within the same trading week. The yield curve has flattened and steepened in alternating sessions, reflecting traders' inability to settle on a consensus view of what comes next.
This uncertainty carries real economic costs. Corporate treasurers are delaying capital expenditure decisions because they cannot price long-term financing with confidence. Banks are tightening lending standards not because loan losses have materialized, but because they cannot model the tail risks. The uncertainty itself becomes contractionary, even before any policy action is taken.
Our take
The honest answer is that central banks are not equipped for this moment. Their frameworks assume that inflation is primarily a monetary phenomenon, controllable through interest rate adjustments that influence demand. But when a naval standoff in the Persian Gulf can add two percentage points to headline inflation overnight, those frameworks become decorative. The Fed and BOE are not being indecisive; they are being rational about the limits of their power. The problem is that admitting those limits publicly would undermine the very expectations management that makes monetary policy effective in normal times. So they issue guarded statements and hope the diplomats solve what the economists cannot.
