Energy shock splits policy outlook as ECB eyes hikes while Fed stays on hold

Summary:

  • Middle East conflict drives renewed energy-led inflation shock
  • Bond yields rise as markets price potential rate hikes
  • ECB expected to begin tightening as soon as next month
  • Europe more exposed to energy price pressures than US
  • Barclays sees two ECB hikes this year
  • Fed unlikely to hike despite shifting rhetoric
  • US less sensitive to energy shock due to domestic supply

Barclays expects diverging policy paths between the European Central Bank and the Federal Reserve as the Middle East conflict drives a renewed inflation shock via energy markets, with Europe seen as significantly more exposed than the United States.

With the conflict now entering its fourth week and uncertainty lingering over its duration, short-term government bond yields across both Europe and the US have moved sharply higher. Markets have begun to price in the risk that central banks may need to tighten policy in response to rising inflation pressures, particularly those stemming from elevated oil and gas prices.

Barclays economists argue that the ECB is likely to begin raising interest rates as soon as next month, reflecting the more immediate and pronounced inflationary impact facing the euro area. Energy costs play a larger role in Europe’s inflation dynamics, and the region remains more vulnerable to supply disruptions tied to geopolitical developments in the Middle East.

The bank expects the ECB to deliver two rate hikes this year as policymakers respond to the acceleration in price pressures, marking a shift toward a more proactive inflation-fighting stance.

By contrast, Barclays does not anticipate the Federal Reserve will follow the same path. While US yields have also risen and markets have flirted with the idea of renewed tightening, the bank’s economists see less urgency for policy action. The US economy is considered less sensitive to energy price shocks, with domestic production helping to cushion the impact of higher global oil and gas prices.

Even so, recent Fed communication suggests a subtle shift in tone. At the latest meeting, two typically dovish policymakers withdrew their dissent against holding rates steady, with one indicating openness to tightening should the conflict prove prolonged. Despite this, Barclays maintains that the threshold for Fed rate hikes remains high, and that policy is likely to stay on hold through the year.

This article was written by Eamonn Sheridan at investinglive.com.

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