The recent escalation in the Middle East, tied to a U.S. and Israeli bombing campaign against Iran, has sent oil prices sharply higher and complicated plans for monetary easing in a wide range of emerging markets. The immediate market reaction - including a near-term surge in crude to almost $120 per barrel, a stronger dollar and rising U.S. Treasury yields - has squeezed the room that central banks had been building to lower rates.
After a sequence of shocks that first came with the COVID pandemic and later with Russia's invasion of Ukraine, many emerging market central banks had begun to view the global economic outlook and disinflationary pressures with more optimism. That tentative easing bias has been interrupted by the fresh geopolitical tension and its knock-on effects for energy prices and investor sentiment.
JPMorgan calculations show how quickly expectations shifted. Shortly before the conflict intensified in late February, analysts had expected 10 out of a sample of 15 major emerging market central banks to cut policy rates by at least 10 basis points within the next six months. By Tuesday after the escalation, that number had fallen to six, while the aggregate amount of expected easing among those still projected to cut had also diminished.
Market observers and analysts say the prompt change in rate-cut probabilities reflects heightened uncertainty over inflation and growth prospects at a time of renewed geopolitical risk. Petar Atanasov, Co-Head of Sovereign Research and Strategy at Gramercy Funds Management, summed up the likely central bank stance: "Central banks across emerging markets are likely to increasingly signal a 'wait and see approach' pending resolution of Iran conflict-related uncertainty."
Emerging Europe sees clearest reversal
The shift in policy expectations has been most notable in emerging Europe, where market pricing for the Czech Republic, Hungary and Poland moved from predicting easing to pricing in possible tightening over the next six months. Officials in Poland have acknowledged that their margin for lowering rates has narrowed in recent days. Colleagues in Hungary and the Czech Republic have publicly recognised the additional risks and uncertainty stemming from the Iran situation.
Reliance on energy imports figures prominently in those sensitivities. Juan Orts, CEEMEA Economist at Societe Generale, noted that countries in Central and Eastern Europe such as Poland and Hungary are particularly exposed to movements in oil prices, an influence that has pushed market-implied policy paths toward greater caution.
Energy-driven balancing act for policymakers
Analysts emphasise that the core challenge facing emerging market central banks is a classic monetary policy trade-off: weighing a potential rise in inflation against already-fragile growth. Rising energy costs act as a tax on consumption and can undermine expansion, while at the same time exerting upward pressure on prices.
"It’s a negative shock for growth," said James Lord, Global Head of FX and EM Strategy at Morgan Stanley. "It’s a sort of tax on consumption, and it’s potentially something that will cause central banks to have tighter policy than they otherwise might given the inflation risks."
In Latin America, market participants pared back expectations for easing in Brazil, though the central bank is still widely expected to cut rates when it announces its decision on March 18. Brazil's policy rate has been held at 15% since last July, following a pause in a prior aggressive tightening cycle; that level represents the highest benchmark rate in nearly two decades.
Turkey, another energy-importing economy with acute sensitivity to inflation, faces its own decision point with a central bank rate announcement scheduled for Thursday. Gramercy's Atanasov expects the Central Bank of the Republic of Turkey to pause its rate-cutting cycle while it assesses both the likely duration of the conflict and the associated economic ripple effects.
Near-term pause, long-term uncertainty
While the immediate effect of the Middle East conflict may be to delay or temper near-term rate cuts, the outlook further ahead remains opaque. The path central banks take will hinge on how persistent the energy price impact proves to be and how much of that feeds through into broader inflation expectations.
Lesetja Kganyago, Governor of the South African Reserve Bank, underlined that underestimating the persistence of higher energy-driven inflation would necessitate a more aggressive - and ultimately costlier - policy response later on. He argued that acting earlier can allow central banks to manage inflation with smoother, less abrupt adjustments over time. "That was the lesson of 2021/2022," Kganyago said. "The central banks that started to act early found that they didn’t have to act aggressively ... in one step, which is what ended up happening with the central banks that only reacted in the second half of 2022."
At present, a combination of elevated oil prices, shifts in currency valuations and higher benchmark yields in developed markets has increased borrowing costs and risk premiums for emerging economies. Although some of the initial market moves have partially reversed, the degree of volatility in inflation and growth forecasts has risen, complicating policy choices and market pricing worldwide.
For now, the dominant posture among many emerging market central banks appears to be a cautious hold. They are likely to await clearer signals on how long higher energy costs will persist and how broad the inflationary fallout will be before resuming previously signalled easing paths.
The near-term policy outlook remains subject to significant geopolitical developments and market reactions. Central bankers and market participants will continue to monitor energy price dynamics, currency movements and sovereign borrowing costs for signs that dictate whether the pause in easing solidifies into a prolonged tightening bias or gives way to renewed cuts once the situation stabilises.