As the Iran war keeps rattling oil prices, global monetary policymakers fear persistent inflation requires fast action to cool it, sparking interest rate rises and speculation about more ahead. It is all wrong and misguided. Not only is sustained “tightening” unnecessary, but it is also a mistake that risks harming the global economy and stocks.
Anti-inflation rate increase talk builds. In September, to much fanfare, the US Federal Reserve hiked policy interest rates by 0.25 percentage points – its first increase since 2023. Earlier this year, the Reserve Bank of Australia and European Central Bank also raised rates multiple times. Most observers expect more by year-end.
Central bankers’ thinking? Globally, many were scarred by 2022’s massively red-hot inflation, a self-inflicted wound created by their massive Covid-era money supply expansion. They think high oil prices risk pumping all prices higher. They think wrongly. But most economists were wrongly trained that way.
As I cameoed here in June, high oil prices alone never fuel true inflation. They drive substitution, mostly dampening luxury goods demand. Data show this. Consider America for its global economic importance. Amid the Iran war’s eruption, US Consumer Price Index inflation climbed from 2.4 per cent annually in January to a high of 4.2 per cent in May. Fears flared, but US CPI soon slowed to 3.4 per cent year-on-year in July as energy prices fell near prewar levels – and stayed there through August, as oil prices rose yet remained below early spring highs.
Oil did not bleed elsewhere. Importantly, it did not stop underlying inflation from slowing. In January, US CPI excluding energy was 2.6 per cent annually. August CPI excluding energy was slightly lower, at 2.5 per cent. Parallel trends hold across Europe and Asia.
War understandably induces fear and uncertainty – and significantly underpins the recent volatility in oil prices. While, yes, oil recently climbed briefly over $120, it fell quickly to around $100 in late September. As my March column forecast, oil fell fast to approximately prewar levels in June. The renewed rise seen in recent months will follow a similar downwards reversal, which is likely under way now.
Central bankers should stop focusing on rocky and volatile commodity markets and start looking inward. Energy did not drive the extreme inflation in 2022. Nor did Covid. Central banks did, by massively increasing the quantity of money in reaction to Covid – by more than 25 per cent globally. As Nobel laureate Milton Friedman taught 60 years ago, inflation is always caused by too much money creation chasing too few goods and services.
Yet through July, US M4 – America’s broadest monetary measure – was up 7.9 per cent year on year. While that is too much and slightly elevated versus the long-term average of 5.9 per cent, it is vastly below the extremely inflationary 30.5 per cent of June 2020.
The eurozone? Its benchmark M3 growth was up 3.4 per cent annually in July – tepid, showing why the ECB rate rises in June and September were not necessary.
A rate increase or two will not wreck global GDP or stocks. There is nothing automatically negative about rate increases. Australia, whose central bank hiked multiple times so far since February, enjoys steady GDP growth and 12 per cent year-to-date stock market returns in US dollars, mirroring global markets.
Rate moves affect lending by raising or lowering the short-term end of yield curves globally. Yield curves depict the gap between short and long interest rates. In the developed world, banks borrow short-term money to fund long-term loans. When long-term rates exceed short-term rates, new loans are profitable, having a direct causal relationship. Potential profitability fosters lending and GDP growth. When short rates exceed long ones, the “inverted” curve creates unprofitable lending, so banks constrict credit, negatively impacting the economy. Hence, an inverted curve is a good, if imperfect, recession warning.
As 2026 started, the 10-year minus three-month US yield curve was 0.54 percentage points. Through to September 21, rising long rates pushed it to 0.87, despite the Fed implementing an interest rate increase. That is bullish. The UK yield curve widened from 0.74 percentage points to 1.19. In the eurozone, the German yield curve spread is 1.01 percentage points. In France, it is 1.77 percentage points. Central bankers have wiggle room, but some of that is volatility from recent global debt fears boosting long rates, which is unlikely to last.
If central bankers are not prudent – and often they aren’t while thinking they are – they could easily flatten or invert global yield curves choking lending, stalling economies and impaling stocks. That is not imminent, but it is a potential risk.
Today does not call for further global tightening. It calls for central bank patience to let current positively structured yield curves work their bullish magic.
