US Federal Reserve expected to hold rates as Iran war clouds inflation outlook

The US Federal Reserve is widely expected to leave its benchmark interest rate unchanged after its two-day meeting concludes Wednesday, AP reported. Policymakers are seen to be more willing to tighten monetary policy when they meet again on September 15–16.

Inflation has remained above the central bank’s 2% target for more than five years. Fed Chair Kevin Warsh, presiding over his second policy meeting, told Congress earlier this month that he had “no tolerance” for elevated inflation.

BNP Paribas strategists Joseph Egelhof and Guneet Dhingra told AP that a surprise rate increase this week was possible. However, they expect policymakers to hold off to avoid unsettling financial markets that are not yet positioned for a hike.


Policymakers may also prefer to wait for more economic data. On Thursday, the Commerce Department will release its first estimate of second-quarter growth and the June personal consumption expenditures price index, the Fed’s preferred inflation gauge.

Only 29% of Wall Street traders expect a rate increase this week while 76% anticipate a hike in September, according to the CME FedWatch tool. That is up from 59% a month ago.

On the prospect of a September rate hike, Egelhof and Dhingra said policymakers’ patience with persistently high inflation was “broadly exhausted,” creating a significant risk of action.

Escalating conflicts with Iran have added uncertainty to the Fed’s outlook. Oil prices briefly surged above $100 a barrel last week as fighting intensified but have since retreated on hopes that the United States and Iran could ease tensions.

Iran’s closure of the Strait of Hormuz after the February 28 US-Israeli attacks triggered a historic oil-supply disruption, leaving crude prices $10 to $15 a barrel higher than a year ago.

Supply risks have intensified as Iran-backed Houthi rebels attack Red Sea shipping and target tankers carrying Saudi oil through the Bab el-Mandeb Strait.

The uncertainty puts the Fed’s inflation fighters in a bind.

“It is possible that the latest rise in prices is a transient blip that will reverse in a heartbeat. Then again, it seems equally that the war with Iran will get worse, that the Strait of Hormuz and Bab al-Mandab will remain blockaded for months or longer, and that energy prices will continue to trend up,’’ wrote Carl Weinberg, chief economist at High Frequency Economics.

“Should the (Fed) set monetary conditions on a hope that oil prices will reverse course and stay low ... or should a central bank eschew wishful thinking and do its job of minimising the probabilities that inflation will exceed target?’’

Inflation has remained above the Fed’s 2% target since 2021. After peaking above 9% in 2022, it eased following 11 rate hikes but has recently stalled. Pressure from the Iran war, tariffs and AI-driven infrastructure spending persists, though slower rent growth and a temporary drop in gasoline prices helped cool inflation in June.

However, several Fed officials have argued that further rate increases may be needed to bring inflation back to the 2% target.

“Sternly staring at inflation until it melts before our withering gaze is not an option,’’ Christopher Waller, an influential member of the Fed’s governing board, said in a speech this month.