Oil above $100 a barrel, rising inflation, and three major central banks raising interest rates within the space of just a few days. September reminded investors that geopolitical conflicts do eventually find their way into monetary policy. The war delivers the price shock, and central banks the interest-rate shock.
The Strait of Hormuz remains the starting point. Persistent disruptions to shipping and attacks on energy infrastructure pushed oil prices well above $100 a barrel at times during the month. What began as a geopolitical risk has long since turned into a very tangible inflation problem. Higher energy prices increase the cost of transportation and production and, ultimately, the cost of everyday life for consumers.
This puts central banks in an extremely uncomfortable position. Neither the European Central Bank nor the Federal Reserve can send additional tankers through the Strait of Hormuz or repair damaged pipelines. And that is precisely the problem. Raising interest rates is not really an appropriate tool for fighting an exogenous supply shock. Higher rates do not produce more oil or reopen blocked trade routes. They can only help prevent the initial price shock from becoming permanently embedded in inflation through wages, inflation expectations and broader price increases.
For the ECB, this trade-off is particularly difficult. The eurozone economy is already on comparatively weak footing. Higher interest rates therefore hit an economy that can hardly afford additional headwinds. In effect, the ECB is trying to contain the indirect consequences of an energy price shock while simultaneously making credit, investment and consumption more expensive. This may be understandable from a monetary-policy perspective, but it is anything but comfortable from an economic one.
In the US, the same move is considerably easier to justify. The American economy remains robust, the labour market is comparatively strong and corporate investment remains high. The Federal Reserve is therefore not only seeking to contain potential second-round effects from the oil price shock; it is also dealing with an economy that is better able to absorb higher financing costs. Against this backdrop, the Fed’s first rate increase since 2023 in September appears far less contradictory than the monetary tightening in the eurozone.
Nevertheless, central banks took action in September. The ECB raised its deposit rate to 2.5% and warned that inflation could remain elevated for longer. A few days later, the Federal Reserve followed with its first rate increase since 2023. The Bank of Japan also raised its policy rate to 1.25%, the highest level in more than three decades. For the time being, little remains of the global easing cycle that markets had long been expecting.
The consequences were particularly visible in bond markets. The yield on ten-year US Treasuries temporarily moved above 5%, while financing costs also rose significantly in Europe and Japan. This matters far beyond the bond market itself. Higher government bond yields make mortgages, corporate borrowing and investment more expensive, while at the same time raising the hurdle rate for equities.
What is therefore remarkable is how resilient equity markets have remained so far. Despite the oil price shock, rising interest rates and growing concerns about government debt, US equities remain in demand. Strong corporate earnings and the continued enormous investment requirements associated with artificial intelligence are helping investors distinguish between problems on government balance sheets and opportunities in the corporate sector. Washington’s debt is increasingly viewed with scepticism, while American companies continue to attract buyers.
Nor is the situation in the oil market entirely bleak. Towards the end of September, Western oil imports from the Middle East had recovered to around 80% of their pre-war level. Producers have developed alternative transport routes, while shipping through the Strait of Hormuz has partially recovered. Further normalisation could significantly reduce oil prices and, with them, inflationary pressure. At the same time, however, growing economic pressure on Iran also increases the risk of renewed escalation.
For the time being, the oil price therefore remains one of the most important variables for capital markets. If it falls sustainably, inflation concerns and interest-rate pressure could ease relatively quickly. If it remains above $100 a barrel or rises sharply again, central banks will be left choosing between uncomfortable alternatives. They cannot eliminate the original price shock; they can only try to prevent it from taking on a life of its own. For the ECB in particular, this is an unenviable task: the war makes energy more expensive, and in trying to contain the consequences, monetary policy makes credit more expensive as well.