Interest rate market chooses optimism, betting on the Iran war to last only a few weeks, not months

After the United States and Israel launched strikes against Iran, the global interest rate market is making a key judgment: this conflict will end within weeks, rather than evolve into a protracted war. While this optimistic expectation is preventing the market from heading towards the worst-case scenario, the sharp rise in energy prices has begun to reshape monetary policy expectations in the UK, Eurozone, and the United States. According to reports from CCTV News and Xinhua News Agency, the United States and Israel launched a large-scale joint military strike against Iran on February 28. On March 5, media reports indicated that following the military actions over the weekend, oil transit volumes through the Strait of Hormuz plummeted to a trickle, and Iran's retaliation threats have caused shipping to come to a standstill. Prices for oil, natural gas, and other energy sources have surged significantly, with natural gas prices doubling since last weekend. Neil Crosby from the commodity research firm Sparta warned: "Forget about the oil surplus issue; the market is currently staring at a huge gap in the global oil market." Nevertheless, the market is still choosing to believe that the duration of the conflict is limited. The probability of the Bank of England cutting interest rates in March has dropped sharply from 75% to 25%, the probability of the European Central Bank raising rates this year has risen to 20%, while the Federal Reserve's path for rate cuts remains largely unchanged—markets bet that Trump has enough political motivation to keep the conflict contained in the short term. However, several economists have clearly stated that if the situation persists for months, inflationary pressures will substantially alter the pace of rate cuts, and may even end the current easing cycle. Bank of England: March rate cut nearly off the table The impact of this conflict on UK monetary policy expectations is the most direct. Just a week ago, the market was betting on a 75% probability that the Bank of England would be the first to cut rates at the March meeting; now, that probability has fallen to 25%. Paul Dales from Capital Economics stated that the surge in natural gas prices is the core variable. "Natural gas prices have doubled since last weekend, but the key is how long these high prices can be sustained and when they will start to affect inflation." He currently maintains his prediction of three rate cuts within the year but adds, "If the situation persists, it’s only a matter of time before we adjust our forecasts." He also pointed out that the March meeting is only a few weeks away, "If there are no clear signs of a downgrade, I believe the central bank will skip this anticipated rate cut." Sanjay Raja from Deutsche Bank provided a more specific quantitative estimate: The current level of oil prices has a direct impact on CPI of about 10 to 15 basis points; if natural gas prices remain high in the coming months, the energy bills for typical dual-fuel users could rise by about 18%, to £1,900 per year. He also noted that the price cap window has just opened, and if the situation in the Middle East calms down in the coming weeks, there is still room for adjustment. Raja also proposed a scenario of a "hawkish rate cut": If the market-implied probability of a rate cut in March rises above 40%, the monetary policy committee may choose to implement a "precautionary" rate cut while simultaneously releasing more cautious forward guidance, which could mean an early end to the current easing cycle and raise expectations for terminal rates European Central Bank: Calm Disrupted, Rate Hike Probability Emerges The outbreak of the Iran war has disrupted the calm maintained by the European Central Bank since last summer. Previously, analysts almost unanimously expected that interest rates in the eurozone would remain in the "comfortable range" of 2% for this year and next; now, the forward rate market has priced in a 20% probability of a rate hike by the European Central Bank within the year. Eurozone inflation data shows that the overall inflation rate in February was 1.9%, slightly below the target. However, analysts point out that the previously existing possibility of inflation being below target this year has shifted to a risk of exceeding it due to the situation in the Middle East. Nevertheless, several analysts believe that the eurozone's resilience to shocks is stronger than during the Russia-Ukraine war in 2022. Marco Valli from UniCredit stated: "The resilience of the eurozone economy over the past year has exceeded expectations, and compared to 2022, energy supply is more diversified and resilient to shocks. The global energy market was in a state of oversupply before this crisis, which also helped. With inflation slightly below target, the European Central Bank has breathing space and can afford to wait and see." Analysts at Pantheon warned that the surge in energy prices will simultaneously dampen consumer and business confidence, threatening an already uncertain growth outlook, and expect that the European Central Bank will not raise rates in the short term. Federal Reserve: Political Logic Supports Market Optimism Compared to the UK and eurozone, the Federal Reserve's policy expectations have been the least impacted. The forward rate market is still almost fully pricing in two rate cuts in 2026, with only a small amount of hawkish sentiment seeping in—last week, the market was pricing in a low probability of a third rate cut, but this expectation has now faded, and the market has not significantly shifted towards a "no rate cuts" direction. Analysts believe that Trump's political interests are the key logic supporting this optimistic expectation. Bernard Yaros from Oxford Economics pointed out: "The Federal Reserve will choose to ignore the price increases brought about by the Iran conflict while being wary of its impact on growth—the consumer is already under pressure, real income growth is stagnating, and higher energy prices will only exacerbate the situation." Analysts generally believe that as the midterm elections approach, any rebound in inflation or damage to consumer purchasing power will put political pressure on Trump, providing a strong incentive for him to end the conflict quickly. Goldman Sachs analysts quantified this from an economic model perspective: Their oil consumption model shows that rising oil prices will drag down GDP growth by about 0.13 percentage points year-on-year in the fourth quarter of 2026, primarily through compressing household real disposable income; however, the increase in energy capital expenditures will partially offset the drag on the consumption side, resulting in a net drag of about 0.1 percentage points. Core Variable: Duration of the Conflict The current divergence in all monetary policy expectations ultimately boils down to one question: How long will this war last? The market's current baseline scenario is that the conflict will end within weeks. If this expectation fails, the policy dilemmas faced by central banks will sharply deepen—the Bank of England may be forced to pause the entire rate-cutting cycle, the probability of a rate hike by the European Central Bank will further increase, and the Federal Reserve will also have to find a new balance between inflation pressures and slowing growth. As Dales from Capital Economics stated, the key difference from 2022 is: at that time, the central bank chose to raise interest rates in response to energy shocks, while the current relaxation in the labor market means that interest rates are more likely to remain "on hold" rather than "rise again." However, regardless, whether the market's optimistic bets can be realized depends on the direction of geopolitical developments, rather than the economic data itself