MacroscopeAsian central banks largely powerless in face of Iran war energy shock

Last month, Brent crude, the international oil benchmark, experienced its largest monthly rise since the launch of the futures contract in 1988 as the war in Iran caused an unprecedented disruption to global energy flows. Brent surged 63 per cent to US$118 per barrel, exceeding the previous record increase in September 1990 following Iraq’s invasion of Kuwait.

The price shock has been even more dramatic in refined products. Jet fuel costs have more than doubled since the war began, with diesel prices roughly double what they were at the start of the year. Even in the United States, whose position as a net exporter of energy reduces its sensitivity to the shock, petrol prices rose above US$4 per gallon for the first time since 2022.

While energy markets remain volatile amid speculation that the war could end relatively soon, concerns about the longer-term consequences of Iran’s effective closure of the Strait of Hormuz are weighing on sentiment. Physical shortages of oil, gas and other strategic commodities will persist long after the conflict winds down as supply chain disruptions linger and inventories are rebuilt.

The initial reaction in bond markets was an inflation scare. The yield on the policy-sensitive two-year US Treasury bond surged from 3.3 per cent just before the war erupted to almost 4 per cent on March 26. Bets that the US Federal Reserve would continue to lower interest rates this year were rapidly unwound, with traders pricing in a significant chance of an interest rate increase later this year.

The inflation scare was more pronounced in Europe and Asia, which are heavily reliant on imported fossil fuels. Last month, consumer prices in the euro zone accelerated sharply amid a steep rise in energy costs. Bond traders expect the European Central Bank to raise interest rates up to three times this year, possibly as early as this month.

In Asia, which is most vulnerable to the fallout from the closure of the strait because of its dependence on energy imports from the Gulf, investors are pricing in rises in borrowing costs in India, South Korea and Thailand. According to Citigroup, markets anticipate borrowing costs in India will rise from 5.25 per cent to 7 per cent.