LONDON, March 16 – A leading international banking organization is advising the world’s central banks to exercise restraint following dramatic energy price increases linked to the Iran crisis, describing the situation as a classic example of when monetary policymakers should avoid hasty reactions.
Energy markets have experienced significant turbulence this month, with oil prices jumping 40% and wholesale gas costs climbing nearly 60%. These sharp increases have drawn parallels to 2022’s inflationary period, when Russia’s military action in Ukraine combined with post-pandemic economic recovery to drive prices dramatically higher.
Major monetary authorities, including America’s Federal Reserve and the European Central Bank, responded to that earlier crisis by implementing their most aggressive interest rate increases in decades. However, they faced criticism for delayed action after initially misjudging the situation as short-lived.
Financial markets have rapidly adjusted their forecasts this time around, with investors anticipating that central banks will want to avoid repeating previous errors. Despite this market sentiment, the Bank for International Settlements has issued guidance recommending a measured approach.
“If it’s a supply shock, and certainly if it’s a temporary one, these are the textbook examples where you should look through and not react with monetary policy,” stated Hyun Song Shin, the organization’s chief economic advisor.
The guidance arrives during a pivotal week for global markets, as the Federal Reserve, European Central Bank, Bank of England, and Bank of Japan are all scheduled to conduct their first policy meetings since the Middle East crisis began on February 28.
Shin noted that the swift changes in market interest rate expectations might reflect current conditions, given the recent memories of 2022’s challenges.
Market expectations have already shifted dramatically, with traders now anticipating only one Federal Reserve rate reduction this year instead of two, while fully expecting a European Central Bank increase by July and assigning an 85% probability to a second hike before year’s end.
“It’s a kind of a knee-jerk reaction,” Shin observed, pointing out that primary inflation indicators haven’t shown similar movement yet, creating “a very confusing picture” overall.
The BIS quarterly report also examined how central banks have modified their public communication strategies following recent global disruptions. The analysis revealed that more institutions are now employing scenario-based illustrations to demonstrate potential risk impacts, supplementing traditional methods like fan charts and qualitative risk assessments.
Many central banks have also moved away from traditional forward guidance about future rate directions, instead publishing their own rate forecasts within the framework of alternative scenarios.
The organization’s current market risk assessment also addressed other volatility episodes from this year, including significant declines in artificial intelligence-related stocks and challenges within private credit markets.
“We have to watch this,” said Frank Smets, deputy head of the BIS monetary and economic department. “But we don’t see any major disruptions at this point.”
