Central Banks face a difficult balancing act
22 MAY, 2026
Interest rates have shown a strong correlation with oil prices. The longer oil prices remain elevated, the greater the likelihood of second-round effects. This is the scenario central banks want to avoid, and their communication has been fairly hawkish since the beginning of the war. In fact, they have been successful, with market inflation expectations remaining well anchored, especially for longer-term yields. This scenario implies that much of the increase in bond yields reflects a rise in real yields. All else being equal, such an increase represents a tightening of financial conditions. Consequently, it will weigh on growth and labor markets, in addition to the direct impact of higher energy prices. Central banks are facing a delicate balancing act: if they do too little, inflation expectations could rise; if they do too much, the economy could slow more than necessary.
Ultimately, the outlook for interest rates depends largely on the trajectory of oil prices and, consequently, on the outcome of the standoff in the Strait of Hormuz. We continue to believe that reopening the strait is in the mutual interest of both parties. We also expect the parties to reach some form of agreement in the coming weeks. The ceasefire has lasted longer than the actual military phase itself. This suggests that both sides have little appetite to resume fighting. However, both sides are betting that the other will yield first under the economic pressure of the blockade. They aim to secure more significant concessions at the negotiating table. Any agreement, however, will likely focus narrowly on the conditions under which the strait will be reopened. It may touch on Iran’s nuclear program, but only marginally, leaving the more controversial details for future negotiations.
We therefore continue to forecast oil prices between $80 and $90 per barrel by year-end. In our view, the market’s implied expectations regarding interest rate hikes are excessive, especially considering that three rate hikes by the ECB are already priced in by the end of the year. Consequently, we expect some retracement in yields once energy prices decline. This decline will likely follow some form of agreement between the United States and Iran.
