The US Federal Reserve left interest rates unchanged for a second meeting in a row on Wednesday, as the Iran war's effect on oil prices complicates the central bank's way forward.
“The implications of developments in the Middle East for the US economy are uncertain,” Fed chief Jerome Powell told reporters after the central bank held rates steady at about 3.64 per cent.
The effective closure of the Strait of Hormuz and Iranian attacks on energy sites across the Gulf have brought a wave of volatility in oil markets. Crude prices have surged since the conflict, with Brent touching $108 a barrel on Wednesday.
Higher oil prices are bringing more concerns about the inflation outlook. This comes as the Fed is still battling to bring inflation back down to its 2 per cent target about five years after its post-pandemic surge.
US President Donald Trump's administration announced two new measures earlier on Wednesday to ease rising oil costs, including waiving a shipping regulation and authorising certain transactions with Venezuela's state-run oil company.
A short-term energy supply shock could deliver an inflationary bump, which could either force the Fed to raise interest rates or delay rate cuts. A sustained increase in prices could also derail the economy and increase unemployment.
Forecasts released alongside its latest rate decision showed the Fed anticipates headline and core inflation to increase by 2.7 per cent this year, up from its December forecasts of 2.4 and 2.5 per cent, respectively.
Mr Powell said near-term inflation expectations have risen in recent weeks, probably “reflecting the substantial rise in oil prices” caused by energy supply disruptions in the region.
Analysts contend the latest energy shock is dissimilar to Russia's invasion of Ukraine in 2022, where oil prices surged to similar levels. But that period was also marked by post-pandemic supply bottlenecks, a red-hot labour market and two rounds of fiscal stimulus that overheated the economy.
When asked if looking through the impact on oil prices would undermine the Fed's credibility on bringing inflation back to target, Mr Powell said the Fed would not let that "colour our decision-making more than is appropriate".
"It's more the thought that it's been five years and we've … had the tariff shocks, we had the pandemic, and now we have an energy shock of some size and duration. We don't know what that's going to be."
Now the labour market is stalled, with its tepid performance last year convincing the Fed to lower rates by 75 cumulative basis points to help juice the economy.
Latest Fed projections show the unemployment rate is expected to remain at 4.4 per cent, unchanged from December, while it slightly bumped up its projections for economic growth this year from 2.3 per cent to 2.4 per cent.
Path forward
Policymakers were already split on where to set interest rates, with one group expressing concern about inflationary pressures before co-ordinated US-Israeli strikes against Iran on February 28, while Mr Powell and others have left the door open for more rate cuts.
Those divisions were apparent in the Fed's so-called dot plot, where every official on the 19-person rate-setting body sets their best guess for where interest rates will be. The median projection showed the Fed still expects to cut rates once this year.
"Take the forecast with a grain of salt because it's subject to very high levels of uncertainty," Mr Powell said.
For now, traders expect the Fed to remain on hold until the fourth quarter owing to inflation fears, with a tiny fraction even anticipating a rate rise could be on the horizon, according to CME Group data.
Any delays in cutting rates – or even raising them – would have implications for borrowers in most Gulf states whose central banks follow Fed decisions because of their currencies' dollar pegs.
In maintaining its “AA/A-1+” rating for the UAE last week, S&P Global Ratings said its base-case scenario forecasts the Emirates' economic and fiscal flexibility would act as buffers against the impacts of the widening US-Israel conflict with Iran.
The ratings agency also affirmed its credit outlooks for Qatar and Saudi Arabia, although it warned the unpredictability over the duration and scale of the Iran conflict also poses significant uncertainty for its forecasts.
The UAE Central Bank earlier on Wednesday announced to help bolster the country's banking sector's stability amid the war.
Powell still quiet on future
Mr Powell, who oversaw his penultimate policy meeting as Fed chief this week, did not say if he would remain on the board of governors, where he can stay for another two years, when his term as leader ends in May.
He is under investigation by the Justice Department over testimony he gave to Congress last year over cost overruns in the Fed's headquarter renovation project. A US judge last week quashed subpoenas in the investigation, which the Justice Department said it would appeal against.
Mr Powell said he has "no intention of leaving the board until the investigation is well and truly over". He has maintained the investigation is a pretext to pressure the Fed into delivering large rate cuts that Mr Trump wants.
The investigation complicates the nomination process for his potential successor Kevin Warsh, himself a former Fed governor. Mr Warsh's nomination is essentially blocked by Republican Senator Thom Tillis, who said he would not vote to advance the nomination until the investigation is resolved.
Mr Powell said he would remain as Fed chief pro-tempore until his successor is confirmed.
"That is what the law calls for. That's what we've done on several occasions, including involving me, and it's what we're going to do in this situation," he said.
