Oil Price Volatility Pushes Rate Cuts Aside... US and Europe Shift to Tightening Mode

Fed likely to cut rates only once this year
70% probability of two rate hikes in Europe
Concerns over inflation as war shows signs of prolongation

As international oil prices fluctuate due to the Middle East war, there is speculation that major countries may shift toward tightening monetary policy.

An employee is organizing US dollars at the Hana Bank Counterfeit Response Center in Jung-gu, Seoul. Photo by Yonhap News Agency

The Wall Street Journal (WSJ), citing CME Group data, reported on the 9th (local time) that investors now see the highest probability that the US Federal Reserve (Fed) will cut interest rates only once this year. As recently as last week, the market had expected two rate cuts in 2026.

There are also voices suggesting that the Fed may keep interest rates unchanged. According to WSJ, analysis of the derivatives market shows that the probability of the Fed maintaining rates at their current level for the rest of the year has risen from 8% a week ago to 18%.

The rise in energy prices can spur inflation by pushing up overall price levels. Expectations that these price increases will continue in the future can fuel inflation expectations, prompting demands for wage hikes and further driving up prices. Before prices spiral out of control, central banks in each country must implement measures to contain inflation. Typically, this involves raising interest rates.

The likelihood of rate hikes is rising not only in the United States but also in Europe. According to major foreign media outlets such as Bloomberg, on the morning of March 10, the European interest rate swap market reflected a 70% probability that the European Central Bank (ECB) would raise its policy rate twice this year by 25 basis points (1bp = 0.01 percentage points) each time. By the end of the year, the expected total rate hikes rose to 40 basis points.

After Iran's airstrikes on February 28 caused oil prices to surge, forecasts for the path of interest rates reversed. Before the airstrikes, the market had expected inflation to fall below the 2% target and for the ECB to keep rates unchanged.

While ECB officials are maintaining a cautious stance ahead of their monetary policy meeting scheduled for March 18-19, they have started to express some concern about inflation due to signs that the war may be prolonged. On March 5, ECB Vice President Luis de Guindos said, "Our baseline scenario is that this situation will be short-lived," but added, "If it lasts longer, there is a risk that inflation expectations could change."

On the same day in the UK, the possibility of further rate hikes within the year caused British government bond prices to fluctuate. The yield on 2-year UK government bonds soared as high as 4.239% during the session, up 0.37 percentage points from the previous close. Bond yields move in the opposite direction to prices. After a joint statement from the finance ministers of the Group of Seven (G7) countries, saying that they could take necessary measures such as releasing strategic oil reserves, the market stabilized somewhat, and the yield increase narrowed to 0.1 percentage points. The 2-year bond yield had fallen by nearly 0.5 percentage points over the previous week. The yield on 10-year government bonds also jumped by up to 0.17 percentage points during the session before the G7 statement, but the increase narrowed to 0.02 percentage points afterward.

Before the war, the interest rate market had expected the Bank of England (BOE), the UK's central bank, to cut its base rate—which currently stands at 3.75%—one or two more times this year. However, as the war continues and oil prices soar, expectations of a rate cut have disappeared, and the probability of one rate hike this year is now reflected at 57%.

Meanwhile, both Brent crude and West Texas Intermediate (WTI) futures for April delivery surged toward $120 per barrel, before plunging below $100 later in the day. With news that the G7 was discussing the release of strategic reserves, prices rebounded sharply, and the entire financial market fluctuated in tandem with oil price swings.

This content was produced with the assistance of AI translation services.