The world’s leading central bankers are stuck.
This week, policymakers in Tokyo, Washington, London and Frankfurt decided in stately order that this was not the time to take action, despite long-stated intentions to shift short-term interest rates. In any case, they concluded that it was better to leave short-term interest rates alone.
The central banks are all facing a gigantic and imponderable problem. Inflation is rising, economic growth is slowing, and it is not clear how long the energy shock caused by the war in Iran or these broader economic impacts will last.
To one degree or another, the bank in each country has been forced to adjust its preferences – with the Bank of Japan delaying presumed interest rate hikes and the others changing and perhaps ultimately even reversing their bias towards lower interest rates.
On Wednesday, Federal Reserve policymakers in Washington said they needed to keep interest rates stable as “developments in the Middle East contribute to a high level of uncertainty about the economic outlook.”
It was probably the last Fed meeting chaired by Jerome H. Powell, and it was unforgettable. Mr. Powell, who has had a rocky relationship with President Trump, announced in a news conference that he would remain on the Fed’s board of governors, repeating a move made by a previous Fed chairman, Marriner Eccles, in 1948.
As I pointed out in December, Mr. Eccles remained on the board after his chairmanship to ensure the central bank’s independence from the White House. Mr. Powell appears to be trying 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 described as attacks from the Trump administration. He added that he intends to remain on the board until a Justice Department criminal investigation into his role in a Fed construction project is “fully completed.”
“These attacks are damaging to the institution and jeopardizing what really matters to the public, which is the ability to conduct monetary policy without taking political factors into account,” he said.
It’s not clear how independent his designated successor as chairman, Kevin M. Warsh, would be if confirmed by the Senate.
The Trump administration has already had a significant impact on central banks. What is noteworthy, however, is that, unlike other global financial crises in recent decades, leaders in Washington are not trying to find a solution. Instead, Mr. Trump is widely seen as the cause of the problem.
Along with Israel, the president launched war with Iran and triggered the largest energy disruption in 20 years, leaving banks unable to know whether their focus should be on rising prices or slowing economic growth.
Lowering interest rates is the fundamental monetary tool for stimulating economic growth. Raising interest rates is the traditional response to rising inflation. But the current energy shock could cause both problems – higher inflation and economic stagnation, in a stubborn and toxic mix known as “stagflation.” There is no single, reliable solution for this.
The last time the United States faced sustained stagflation due to an energy shock was in the 1970s and 1980s, and it took double-digit interest rates and two recessions engineered by Fed Chairman Paul A. Volcker to contain it. Nobody wants to face this dilemma. The banks hope that the war will end and these economic problems will simply disappear.
Japan and the bond market
That’s why the Bank of Japan, which finally started raising interest rates last year after decades of deflationary stagnation, decided to take a breather. It left its key interest rate at 0.75 percent – an exceptionally low level, but much higher than the sub-zero interest rates that prevailed from 2016 to early 2024.
The Bank of Japan pioneered an unconventional monetary policy called quantitative easing, in which a central bank buys securities to stimulate the economy more than would be possible through interest rate cuts alone. It has decoupled the economy from these policies, but is slowing its “normalization of monetary policy” due to 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 continues and crude oil prices remain elevated.”
These risks include a collapse of global financial markets. If Japanese interest rates rose while those in Europe and the United States fell, the Japanese yen would likely appreciate. That could disrupt the “yen carry trade,” in which investors borrow in low-interest-rate yen and buy bonds or stocks denominated in dollars or euros.
Such a disruption occurred last year after the Trump administration imposed the highest tariffs since the 1930s and triggered turmoil in global markets, leading to big losses for U.S. bond investors. This bond crisis, in turn, triggered a crash in the US stock market.
Because Japan is a major trading nation, it is particularly vulnerable to external shocks such as tariffs, and its reliance on imported energy has made the disruption of oil and liquefied natural gas shipments from the Persian Gulf through the Strait of Hormuz particularly painful. Avoiding abrupt monetary policy changes while preparing for intervention if the domestic economy runs into difficulties could improve market stability away from Japan.
Euros, pounds and dollars
In contrast to the Bank of Japan, the European Central Bank cut interest rates in its latest move in June. Since then, the Frankfurt bank has struggled with the impact of Trump’s tariffs and higher energy costs due to Russia’s war in Ukraine, as well as the energy shock caused by the war in Iran.
As a net energy importer with a slower-growing economy than that of the United States, Europe finds itself in a difficult position. Christine Lagarde, the bank’s president, has warned that she will have to act quickly if inflation spirals out of control, but stressed that the oil shock is likely to have a delayed impact. With unemployment hovering around 6 percent and economic growth forecast to be below 1 percent this year, higher interest rates could tip Europe into 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. In addition, Merz said that the USA “obviously went into this war without a strategy” and had “no really convincing strategy in the negotiations either.”
The European Union finds itself in the uncomfortable role of easing the pain of a country that was undoubtedly an ally before Mr. Trump. The European Central Bank is watching, waiting and holding on.
In London, the Bank of England was in an even worse situation. It has been cutting interest rates since December 2024 to stimulate the economy. But the International Monetary Fund warned in April that Britain was likely to be hit hardest by the war in Iran of any advanced economy. Due to the risk of inflation, the bank may have to raise interest rates – which could further weaken the economy.
While the banks’ policymakers were meeting, King Charles III was traveling. to visit the United States to strengthen strained Anglo-American relations. Like the others, the bank could not agree on a direction for interest rates. While it waits for the war to end, it stands still.
There was an exception to this pattern in Brazil, where the central bank cut its key interest rate by 0.25 percentage points on Wednesday. Nevertheless, the key interest rate was 14.5 percent. While rising energy prices are hurting consumers, Brazil, like the United States, is a net energy exporter. This somewhat protects its economy from the global oil shortage. Like the United States, Brazil will also have national elections in the fall. Its president, Luiz Inácio Lula da Silva, is likely to benefit from a further fall in interest rates.
However, if the war continues, it is unlikely that interest rates will fall elsewhere without causing an even larger crisis triggered by a recession.
For most central banks, remaining stable seemed the sensible path for now. Policymakers are proceeding with caution when navigating treacherous waters.