Following military strikes by the United States and Israel against Iran, global interest rate markets are making a crucial judgment: the conflict will conclude within weeks, rather than evolving into a protracted war. While this optimistic outlook is preventing markets from pricing in a worst-case scenario, the sharp rise in energy prices has already begun to reshape monetary policy expectations for the UK, the Eurozone, and the United States.
According to reports, the US and Israel launched a large-scale joint military strike on Iran on February 28. By March 5, media reports indicated that oil transit through the Strait of Hormuz had plummeted to a trickle following military actions over the weekend, with threats of Iranian retaliation bringing shipping to a standstill. Prices for oil, natural gas, and other energy commodities surged significantly, with natural gas prices doubling since the previous weekend.
Neil Crosby from the commodities research firm Sparta warned, "Forget about oil surpluses; the market is now staring at a massive deficit in the global oil market."
Despite this, markets are currently choosing to believe the conflict will be short-lived. The probability of a Bank of England rate cut in March plunged from 75% to 25%, while the likelihood of a European Central Bank rate hike within the year rose to 20%. The expected path for Federal Reserve rate cuts, however, remained largely unchanged—markets are betting that political motivations will drive the US administration to contain the conflict within a short timeframe.
Nevertheless, several economists have clearly stated that if the situation persists for months, inflationary pressures could substantially alter the pace of rate cuts and potentially even end the current easing cycle.
**Bank of England: March Cut Nearly Ruled Out** The impact of the conflict on UK monetary policy expectations has been most direct. Just a week ago, markets were pricing in a 75% probability that the Bank of England would be the first to cut rates at its March meeting; now, that probability has fallen to 25%.
Paul Dales of Capital Economics stated that the spike in natural gas prices is the core variable. "Natural gas prices have doubled since last weekend, but the key is how long high prices persist and when they begin to affect inflation." He currently maintains a forecast for three rate cuts this year but added, "if the situation continues, it's only a matter of time before forecasts are adjusted." He also noted that with the March meeting just weeks away, "without clear signs of improvement, I think the Bank will skip this expected cut."
Deutsche Bank's Sanjay Raja provided more specific quantitative estimates: the direct impact of current oil price levels on CPI is approximately 10 to 15 basis points; if natural gas prices remain high in the coming months, the average dual-fuel user's energy bill could rise by about 18%, to £1,900 annually. He also pointed out that the price cap review window has just opened, leaving room for adjustment if the Middle East situation calms in the coming weeks.
Raja also raised the possibility of a "hawkish cut" scenario: if market pricing for a March cut probability rises above 40%, the Monetary Policy Committee might opt for a single "insurance" rate cut while simultaneously issuing more cautious forward guidance. This could imply an earlier end to the current easing cycle and push up terminal rate expectations.
**European Central Bank: Calm Shattered, Hike Probability Emerges** The outbreak of conflict with Iran has shattered the calm maintained by the European Central Bank since last summer. Previously, analysts were nearly unanimous in expecting eurozone interest rates to remain within a "comfortable range" of 2% this year and next; now, forward rate markets are pricing a 20% probability of an ECB rate hike within the year.
Eurozone inflation data showed a headline rate of 1.9% in February, slightly below target. But analysts note that the pre-existing possibility of inflation undershooting the target this year has now transformed into a risk of overshooting due to the Middle East situation.
However, several analysts believe the eurozone's resilience to this shock is stronger than during the 2022 Russia-Ukraine war. UniCredit's Marco Valli stated, "The eurozone economy has shown greater-than-expected resilience over the past year. Compared to 2022, energy supplies are more diversified and shock-resistant. The global energy market was in a state of oversupply before this crisis, which also helps. With inflation slightly below target, the ECB has breathing room and can afford to wait and see."
Analysts at Pantheon warned that the jump in energy prices will simultaneously dampen consumer and business confidence, threatening an already uncertain growth outlook, and they expect the ECB will refrain from hiking rates in the short term.
**Federal Reserve: Political Logic Underpins Market Optimism** Compared to the UK and the Eurozone, Federal Reserve policy expectations have been the least affected. Forward rate markets are still almost fully pricing in two rate cuts for 2026, with only minor hawkish sentiment creeping in—last week, markets were pricing a small probability of a third cut, an expectation that has now faded, but there has not been a significant shift towards pricing out cuts entirely.
Analysts believe that political interests are a key factor supporting this optimistic outlook. Bernard Yaros of Oxford Economics pointed out, "The Fed will likely look through price increases stemming from the Iran conflict, while remaining vigilant about the impact on growth—consumers are already under pressure, with real income growth stagnating; higher energy prices will only add to the burden."
Analysts widely believe that with midterm elections approaching, any rebound in inflation or erosion of consumer purchasing power would create political pressure, providing a strong incentive for the administration to end the conflict swiftly.
Analysts at Goldman Sachs provided a quantitative perspective based on economic models: their oil consumption model suggests that higher oil prices would drag on Q4 2026 GDP growth by approximately 0.13 percentage points year-on-year, primarily by squeezing households' real disposable income. However, increased energy capital expenditure would partially offset the drag from consumption, resulting in a net drag of around 0.1 percentage points.
**Core Variable: Duration of the Conflict** Ultimately, all divergence in current monetary policy expectations boils down to the same question: how long will the war last?
The market's current base case is for the conflict to end within weeks. Should this expectation prove wrong, the policy dilemmas facing central banks would intensify dramatically—the Bank of England could be forced to pause its entire easing cycle, the probability of an ECB hike would rise further, and the Fed would have to recalibrate the balance between inflationary pressures and slowing growth.
As Capital Economics' Dales noted, a key difference from 2022 is that back then, central banks chose to hike rates in response to the energy shock, whereas current slack in the labor market suggests rates are more likely to be "held steady" rather than "hiked again." Regardless, whether the market's optimistic bets pay off will depend on the trajectory of geopolitics, not economic data alone.
