Global Central Banks at a Crossroads: Will the 2022 Inflation Nightmare Return?

Source: 21st Century Business Herald Author: Wu Bin

In 2022, the supply gloom brought by the COVID-19 pandemic had not yet dissipated, when the Russia-Ukraine conflict suddenly erupted, and inflation shocks were still fresh in memory. Although price increases in major economies reached double digits at the time, institutions like the Federal Reserve and the European Central Bank once confidently believed in a “transient inflation” theory. Their delayed responses ultimately led to persistent high inflation, drawing widespread criticism of their policies.

Four years later, a similar scene is unfolding again. The Iran-U.S. conflict has caused oil prices to surge past $100, igniting a new inflation storm. About 20 central banks worldwide will hold monetary policy meetings this week, covering nearly two-thirds of the global economy. Among the G10 central banks, eight will be making rate decisions. With the Iran-U.S. conflict posing a fresh inflation threat, many central banks may be forced to delay rate cuts or even consider raising interest rates in certain cases.

However, policy adjustments are not yet urgent. Besides the Reserve Bank of Australia, which is expected to raise rates again, the Federal Reserve, ECB, and Bank of England are all likely to keep rates steady while assessing how soaring energy costs will impact consumer prices and economic growth. Future monetary policy will largely depend on how long the Middle East conflict persists. If the situation again pushes up prices, hampers economic growth, or causes sharp currency fluctuations, central banks are prepared to intervene at any time.

Will the 2022 inflation nightmare repeat itself this time? Will global central banks make the same mistakes again?

The Iran-U.S. conflict ignites a new inflation puzzle

Amid rising oil prices, the Federal Reserve, ECB, and Bank of Japan are set to announce their rate decisions this week, with investors closely watching for key signals.

Wu Qidi, director of the SourceReach Securities Research Institute, told 21st Century Business Herald that under the backdrop of rising oil prices driven by the Iran-U.S. conflict, central banks face a dilemma between controlling inflation and maintaining growth. Currently, a “data-dependent approach” has become the common choice among major central banks. It is expected that most will keep rates unchanged this week, but their policy guidance will likely turn hawkish to prepare for possible tightening later.

Market expectations are that the Fed will hold rates steady, but the outlook for rate cuts has shifted significantly. The dot plot may show only one rate cut this year, as officials assess the risk of stagflation. The ECB is also likely to keep rates unchanged but may signal a hawkish stance to bolster market confidence in its inflation target, possibly raising rates once this year. The Bank of Japan is expected to maintain current rates, though rising energy prices and imported inflation could accelerate its future rate hikes.

Dong Zhongyun, chief economist at AVIC Securities, analyzed that the ongoing Iran-U.S. conflict has driven a sharp surge in global oil prices and expectations. Brent crude has already broken through $100 per barrel, with futures remaining above that level, compared to just $63 at the end of last year. The rapid increase injects significant uncertainty into the already slowing global inflation trend.

The key trigger for this round of oil price surge is Iran’s blockade of the Strait of Hormuz, with future shipping expectations depending on the evolving geopolitical game among the U.S., Iran, and Israel. The geopolitical uncertainty, using the duration of the Strait blockade as a transmission channel, makes the evolution of global inflation even harder to predict. Dong noted that since the conflict has only been ongoing for about half a month, the actual inflation impact has yet to fully manifest. For central banks worldwide, maintaining a “wait-and-see” stance until clearer inflation data emerges is a rational choice.

Regarding the Fed, ECB, and Bank of Japan, their situations differ.

For the Fed, Dong emphasizes that weak labor market data combined with rising oil prices make it difficult to achieve both inflation control and economic stability simultaneously. The main signal this week will likely be extreme policy patience and a rebalancing of dual objectives. Powell may stress that the weak February non-farm payroll data needs further observation to determine if it signals a trend, while also acknowledging inflation risks from rising oil prices. This stance, which considers both employment and inflation data, suggests that market expectations for rate cuts will be pushed back. The Fed is also likely to signal that it is not considering rate hikes now or in the near future, trying to balance hawkish inflation concerns with dovish employment worries.

For the ECB, given its higher dependence on external energy and the recent memory of the 2022 energy crisis triggered by the Russia-Ukraine conflict, the ECB’s signals are expected to be more hawkish than the Fed’s. If energy prices stay high, the ECB may further tighten its stance to address inflation risks and keep policy options open.

For the Bank of Japan, rising oil prices pose a classic stagflation challenge—higher import costs push up inflation, but simultaneously harm economic growth and corporate profits. Dong predicts that the BOJ’s signals will be the most cautious and contradictory. On one hand, yen depreciation to 160 against the dollar and the risk of unanchored inflation suggest a need for hawkish rate hikes to stabilize the currency. On the other hand, aggressive hikes could trigger a fiscal crisis given Japan’s high government debt, and won’t solve supply-side energy shortages. The BOJ is expected to emphasize that current inflation is a “temporary supply shock” and rely on government fiscal subsidies rather than monetary policy to offset energy costs, while warning against excessive yen depreciation.

Divergence among major central banks

The Reserve Bank of Australia was the first major developed market bank to raise rates this year, on March 17, increasing the benchmark rate by 25 basis points to 4.10%, marking its second consecutive rate hike in 2023.

Wu Qidi noted that the rate hike reflects Australia’s resilient economy. Q4 2022 GDP grew by 2.6 year-over-year, exceeding the 2% potential growth rate; January CPI rose 3.8% YoY, above the 2-3% target range; and the unemployment rate remained low.

However, internal debates within the RBA reveal deep divisions. The decision to raise rates narrowly passed 5-4, indicating differing views on the economic outlook. Doves worry that further hikes could dampen already fragile consumption and growth. This suggests future rate hikes will be highly data-dependent, with possible policy swings based on incoming data.

Dong believes Australia’s early rate hikes stem from its unique economic situation—unlike other major economies, which are experiencing demand slowdown after prolonged tightening, Australia’s economy remains notably resilient. Its inflation is driven more by domestic demand, corporate investment, and a buoyant labor market, rather than solely by imported energy prices. Therefore, the RBA’s rate hikes are driven by the need to address domestic inflation, with Middle East geopolitical events exacerbating this necessity rather than being the primary cause.

Market expectations are that the RBA will continue raising rates, while the BOJ and ECB may also hike this year. The Fed, however, is unlikely to raise rates further, leading to a highly divergent outlook among central banks.

This special case of Australia highlights the current multi-dimensional divergence in global monetary policy, rather than a simple hawkish vs. dovish dichotomy.

Dong emphasizes that for the Fed, without Australia’s economic resilience or the ECB’s urgency to combat imported inflation, it finds itself in a dilemma—either pause rate hikes or risk fueling inflation, thus remaining in a “data-dependent” stance.

For the ECB, although its economic outlook is weaker than the U.S., it faces more direct energy shocks. If it is forced to hike during a slowdown due to imported inflation, it would resemble a stagflation scenario similar to 2022, but with a worse demand outlook.

For the BOJ, the situation is most fragmented. Yen depreciation to 160 raises inflationary pressures, suggesting a need for rate hikes, but high government debt constrains aggressive tightening, risking fiscal crises. The BOJ’s policy will likely be caught between defending the yen and maintaining fiscal stability.

Fundamentally, Dong argues that the core reason for this divergence among central banks lies in their different economic positions in response to the same geopolitical shocks.

Divergent monetary policies are rooted in structural differences. Wu notes that the divergence reflects varying inflation pressures and growth drivers. The Eurozone, as a net energy importer, is highly sensitive to oil shocks and faces increased pressure to hike rates to curb inflation. The Fed faces a “stagflation” dilemma—raising rates risks worsening employment, while cutting risks fueling inflation—thus it remains cautious, awaiting more data. The BOJ is mainly constrained by rising energy prices and yen weakness, with rate hikes aimed at normalizing policy and easing currency depreciation.

Will the 2022 inflation nightmare recur?

In 2022, the Russia-Ukraine conflict caused major economies’ inflation to reach double digits. If the Iran-U.S. conflict persists longer this time, will the inflation nightmare of 2022 reappear?

Comparing the two, Dong sees similarities: both occur near critical turning points in central bank cycles—2022 at the start of tightening, now in the middle of easing; both are driven by energy supply shocks that directly boost inflation expectations.

However, the global economic contexts differ significantly. Dong explains that in 2022, demand was overheated post-pandemic, and supply shocks amplified inflation. Currently, global demand is not overheated but relatively weak, which suppresses the transmission of supply-side inflation. Policy space also differs: in 2022, despite painful rate hikes, central banks had room to tighten aggressively; now, many have already cut rates multiple times and are less able to hike further. Additionally, policy coordination has shifted from unity to divergence—while 2022 saw a consensus on rate hikes to fight inflation, today’s central banks are more divided due to different economic cycles and external conditions.

Therefore, Dong believes the probability of a 2022-style inflation nightmare repeating is low. The more likely scenario is that major economies are stuck in a stagflation trap of wanting to hike but being unable to. However, if the Strait of Hormuz blockade extends significantly or geopolitical tensions escalate, it could still trigger unexpected inflation shocks—an important tail risk to monitor.

Wu Qidi also notes that compared to 2022, the macro environment has fundamentally changed, making a repeat of the inflation nightmare less likely.

The initial inflation environment was very different. Before 2022, pandemic-related supply chain disruptions and large fiscal stimuli pushed inflation to 40-year highs. Now, U.S. CPI growth has been on a downward trend since late 2022, with a very different starting point.

Energy’s role in inflation has also diminished. Over recent years, service sector inflation has increased, and energy’s weight in the CPI basket has decreased. The energy transition has also reduced oil price elasticity. Past experiences have made central banks, especially the ECB, more cautious about energy-driven inflation, which will influence market expectations and policy actions.

Looking ahead, Wu warns that the key variable is the duration and intensity of the Iran-U.S. conflict. If it leads to a long-term blockade of the Strait of Hormuz, it could cause a severe energy supply crisis, raising inflation and constraining growth simultaneously. In such a scenario, central banks will face a more complex environment and difficult policy choices.

The misjudgment of “transient inflation” four years ago is still fresh in memory. As the world faces a crossroads again, can policymakers break free from past inertia and find a narrow path for a soft landing amid stagflation? The challenge is already here.

(Edited by: Wen Jing)

Keywords: Inflation