The ongoing conflict in the Middle East, particularly disruptions in Qatar and Iran, has led to a significant reset in global oil prices, with TD Securities maintaining a new baseline of $90-95 per barrel for 2026, compared to $65 before the crisis [1]. Even a 10% rise in oil prices is estimated to add 0.3%-0.4% to headline inflation in the short term, which is expected to limit early rate moves by the ECB and BoE, pushing any changes to the second half of the year [1]. The inflation hit is anticipated to precede any growth shock, similar to the Russia-Ukraine crisis [1].
The Federal Reserve's March FOMC meeting resulted in no rate change and minimal forward guidance, but markets quickly repriced toward a more hawkish path due to rising inflation expectations from higher energy prices [2]. Before the conflict, markets expected around 60bp in rate cuts by December, but now see nearly 18bp of tightening, shifting from two cuts to almost a full hike by year end [2]. BNY notes that the rate path remains highly uncertain, with the duration of the war and energy price increases as major unknowns [2].
In Japan, Commerzbank reports that inflation fell more than expected in February, with a year-over-year increase of just 1.3%, down 0.2 percentage points from January [3]. Despite rising oil prices, disinflationary trends predominate, and the Bank of Japan is likely to react conservatively to energy cost increases [3]. Governor Kazuo Ueda expects underlying inflation to accelerate moderately, supported by a tight labor market and active wage-setting behavior, and will guide policy to achieve inflation targets with wage gains [4]. The USD/JPY pair rose 0.13% to 158.65 following Ueda's comments [4].
European markets are poised to open lower, with the FTSE 100 expected down 0.3%, Germany's DAX down 0.5%, and France's CAC 40 also down 0.5%, as investors monitor the Iran conflict [6]. Oil prices rebounded Tuesday morning, with Brent crude futures rising about 3% to above $100 after falling sharply on Monday following U.S. President Trump's comments about a potential resolution to the conflict, which Tehran later denied [6]. Gold extended losses, trading 0.4% lower at $4,386.69 an ounce [6].
In currency markets, the EUR/GBP cross traded flat around 0.8650 amid volatile sessions driven by geopolitical tensions and shifting central bank expectations [5]. The ECB and BoE both held rates steady last week, but mounting inflation fears have spurred expectations of rate hikes, with Goldman Sachs predicting two 25bp hikes by the ECB in April and June [5]. The BoE signaled readiness to act against risks from the Middle East conflict, prompting traders to bet on higher borrowing costs later this year [5]. The UK CPI report due Wednesday is expected to show a 0.4% MoM increase, which could support GBP if hotter than expected [5].
CONCLUSION
The Middle East conflict has triggered a surge in oil prices, fueling inflation and prompting global markets to reprice interest rate expectations. Central banks in the U.S., Europe, and Japan are responding cautiously, with rate hikes now seen as more likely later in the year. Equity markets are under pressure, and currency volatility persists as investors await further developments and key economic data.