The world’s leading central bankers are stuck.
In stately succession this week, policymakers in Tokyo, Washington, London and Frankfurt decided that despite long-stated intentions to shift short-term interest rates, this was not the time to take action. In each case, they concluded that they had better just leave short-term interest rates alone.
The central banks all face a gigantic and imponderable problem. Inflation is surging, economic growth is slowing and it’s not clear how long the energy shock set off by the war in Iran or these broader economic effects will last.
To one degree or another, the bank in each jurisdiction has been forced to adjust its preference — with the Bank of Japan delaying presumed rate increases and the others altering, and perhaps ultimately reversing, a tilt toward lower rates.
In Washington on Wednesday, Federal Reserve policymakers said they needed to hold rates steady because “developments in the Middle East are contributing to a high level of uncertainty about the economic outlook.”
It was probably the last Fed meeting with Jerome H. Powell as chair, and it was a memorable one. Mr. Powell, who has had a rocky relationship with President Trump, announced in a news conference that he would remain on the Fed board of governors, echoing a move made in 1948 by a previous Fed chair, Marriner Eccles.
As I pointed out in December, Mr. Eccles stayed on the board after his chairmanship in an effort to secure the central bank’s independence from the White House. Mr. Powell appears to be trying to do much the same thing.
In his news conference, Mr. Powell said he would seek to preserve the Fed’s autonomy in the face of what he depicted as assaults by the Trump administration. He added that he intended to remain on the board until a Justice Department criminal investigation into his role in a Fed construction project “is well and truly over.”
“These attacks are battering the institution and putting at risk the thing that really matters to the public, which is the ability to conduct monetary policy without taking into consideration political factors,” he said.
It’s not clear how independent his designated successor as chair, Kevin M. Warsh, might be if confirmed by the Senate.
The Trump administration has already had major effects on central banking. But what’s remarkable now is that unlike the other global financial crises of the last few decades, this isn’t one for which leaders in Washington are trying to devise a solution. Instead, Mr. Trump is widely viewed as being the cause of the problem.
Along with Israel, the president started the war with Iran and set off the biggest disruption in energy supplies in the last 20 years, making it impossible for the banks to know whether soaring prices or weakening economic growth ought to be their main focus.
Lowering interest rates is the basic monetary tool for spurring economic growth. Raising rates is the conventional response to rising inflation. But the current energy shock might create both problems — higher inflation and economic stagnation, in an intractable and toxic blend known as “stagflation.” There’s no single, reliable fix for that.
The last time the United States faced persistent stagflation because of an energy shock was in the 1970s and 1980s, and it took double-digit interest rates and two recessions, engineered by the Fed chair, Paul A. Volcker, to subdue it. No one wants to confront that dilemma. The banks are hoping that the war ends and that these economic problems just go away.
Japan and the Bond Market
That’s why the Bank of Japan, which had at last begun raising interest rates last year after decades of deflationary stagnation, decided to take a breather. It left its policy rate at 0.75 percent — an extraordinarily low level but much higher than the below-zero rates that prevailed from 2016 until early 2024.
The Bank of Japan pioneered the unconventional monetary policy known as “quantitative easing,” in which a central bank buys securities in an effort to fuel the economy more than interest rate reductions alone can do. It has been weaning the economy from those policies, but is slowing its “monetary policy normalization” because of the war.
In a policy review published on Tuesday, the bank warned of greater financial risks “if the turmoil surrounding the situation in the Middle East becomes prolonged, and crude oil prices remain elevated.”
Those risks include an unraveling of world financial markets. If Japanese interest rates were to move higher while those in Europe and the United States dropped, the Japanese yen would probably appreciate in value. That could disrupt the “yen carry trade,” in which investors borrow in low-yielding yen and buy dollar- or euro-denominated bonds or stocks.
Such a disruption occurred last year, after the Trump administration imposed the steepest tariffs since the 1930s and set off turmoil in world markets, which included big losses for U.S. bond investors. That bond rout, in turn, sent the U.S. stock market tumbling.
Because Japan is a major trading nation, it is particularly vulnerable to external shocks like tariffs, and its dependence on imported energy has made the interruption in oil and liquid natural gas traffic from the Persian Gulf through the Strait of Hormuz especially painful. Avoiding abrupt monetary policy shifts, while preparing to intervene if the domestic economy runs into trouble, could improve market stability far from Japan.
Euros, Pounds and Dollars
Unlike the Bank of Japan, the European Central Bank cut rates in its last move, back in June. Since then, the bank in Frankfurt has been grappling with the effects of the Trump tariffs and higher energy costs stemming from Russia’s war in Ukraine, as well as the energy shock from the war in Iran.
As a net energy importer, with a slower-growing economy than that of the United States, Europe is in a difficult position. Christine Lagarde, the bank’s president, has warned that the it must act swiftly if inflation gets out of control, yet she has stressed that the oil shock is likely to have lagged effects. With an unemployment rate at about 6 percent and economic growth projected to be below 1 percent this year, higher interest rates could throw Europe into a recession.
Tensions with the United States are high. Friedrich Merz, chancellor of Germany, the European Union’s largest economy, said on Monday that the United States was “being humiliated” by Iran. Furthermore, Mr. Merz said the United States “quite obviously went into this war without any strategy” and had “no truly convincing strategy in the negotiations, either.”
The European Union is in the uncomfortable role of trying to mitigate pain inflicted by a country that, before Mr. Trump, was unquestionably an ally. The European Central Bank is watching, waiting and enduring.
In London, the Bank of England was mired in an even more excruciating predicament. It has been lowering interest rates since December 2024 to stimulate the economy. But the International Monetary Fund warned in April that of all advanced economies, Britain is likely to be hit hardest by the war in Iran. Because of the inflation threat, the bank may need to raise rates — which could weaken the economy further.
Even as bank policymakers convened, King Charles III was touring the United States in a visit aimed at bolstering strained Anglo-American ties. Like the others, the bank was unable to settle on a direction for interest rates. While waiting for an end to the war, it is standing pat.
One exception to this pattern occurred in Brazil, where the central bank lowered its benchmark rate by 0.25 percentage points on Wednesday. Even so, the benchmark policy rate stood at 14.5 percent. While surging energy prices are hurting consumers, Brazil is a net energy exporter, much like the United States. This buffers its economy somewhat from the global oil shortfall. Also like the United States, Brazil has national elections in the fall. Its president, Luiz Inácio Lula da Silva, is likely to benefit if interest rates decline further.
If the war continues, however, lower interest rates aren’t likely to arrive elsewhere without an even greater crisis, one brought about by a recession.
For now, for most central banks, holding steady has seemed the sensible course. Policymakers are proceeding with caution as they navigate treacherous waters.
Jeff Sommer writes Strategies, a weekly column on markets, finance and the economy.
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