Weekly Update -Iran War: excessive pressure on interest rates?

The war in Iran is entering its fourth week with a very uncertain outcome at this stage and energy prices that remain at high levels. As a result, both consensus forecasts and financial markets have sharply revised their inflation expectations, with the OECD now anticipating inflation of 4% in the United States and 3% in the euro area, while still maintaining a constructive outlook for growth. The main reaction in financial markets has been a significant adjustment in short-term interest rates, as expectations of monetary policy tightening are revised upward. The risk is that this tightening of financial conditions continues and adds additional pressure on growth.

A month of tensions. The war in Iran began on February 27, and the outcome of the conflict remains highly uncertain at this stage. The Strait of Hormuz remains almost closed, maintaining strong pressure on energy markets. Oil prices are therefore holding at high levels, around 110 dollars per barrel, an increase of nearly 80% since the beginning of the year. Futures markets, however, continue to anticipate a gradual easing, with prices expected to hover around 90 dollars during the summer and close to 80 dollars by the end of the year. Gas prices have also risen sharply compared to their levels at the end of last year (+86% since the beginning of the year for the European contract), although they remain well below the peaks reached in 2022 during the war in Ukraine. One month after the start of the conflict, tensions in energy markets are therefore significant, but remain—at this stage—less intense, both in magnitude and duration, than during the 2022 shock.

Inflation forecasts revised upward, with little adjustment to growth. The OECD has just released an update of its global economic outlook. While the institution has kept its growth projections almost unchanged, it has revised its inflation expectations upward, by more than one percentage point for 2026. Major central banks, which met last week, have also adjusted their assessment in this direction. This view is now widely shared by the economist consensus, with revisions focused on inflation rather than any significant reassessment of the growth outlook.

A sharp reaction in interest rates. Bond markets quickly integrated the geopolitical shock, particularly in the euro area. Sovereign yields have risen across both long and short maturities: the German and French 10-year yields now stand at 3.06% and 3.8%, respectively, while 2-year yields have reached 2.70% and 2.89%. This movement reflects a significant upward revision in inflation expectations, much more pronounced than what appears in institutional and consensus macroeconomic forecasts.

Our central scenario remains unchanged, but vigilance is needed. The main risk today does not lie in a sustained inflationary surge nor in an imminent tightening of monetary policies, but rather in an excessive rate tightening driven by financial markets — a tightening that could slow growth even before central banks have the opportunity to react.

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