Central Banks Shift Back to Tightening as Energy Prices Bite

Major developed-market central banks have reversed their monetary easing stance in response to renewed energy-price pressures from the prolonged Middle East conflict. The US Federal Reserve, European Central Bank, and Bank of Japan raised interest rates in September, while the Bank of England debated whether another increase was necessary.

The US Federal Reserve hiked its federal funds target range by 25 basis points to 3.75%-4.0%, citing elevated inflation and uncertainty due to geopolitical developments. This marked a shift from three rate reductions in 2025 that had brought the range down to 3.50%-3.75% by December.

The European Central Bank also returned to tightening, increasing all three key policy rates by 25 basis points on September 10. It directly linked the decision to the Middle East conflict, stating it continued to generate inflationary pressure and that inflation was expected to remain above its 2% target for an extended period.

The renewed tightening has implications beyond the economies directly affected, as higher policy rates and bond yields in major developed markets can keep global financing conditions restrictive, increasing borrowing costs and affecting capital flows to emerging and developing economies.