An inflation shock similar to that caused the ten-fold rise in energy prices in 2022 is on the way. As the war in Iran enters day eleven it's still too early to be measurable, but central banks around the world are already issuing warnings that planned cuts may be postponed and bond markets are reacting badly to the potential for sharp price rises.

In an early warning sign, debt markets had their worst week in more than a year this week after energy prices surged.

The Middle East conflict has forced traders to dump bets on interest rate cuts in big economies. UK gilts have suffered their worst week since the country’s 2022 pension fund crisis, pushing the 10-year yield up 0.39 percentage points to 4.62%, the. Financial Times reports. The US 10-year Treasury yield is up 0.17 percentage points at 4.13%, the biggest rise since the trade war sell-off in April last year. And short-term debt has borne the brunt of the blow. Two-year German yields rose last week 0.3 percentage points to 2.31%, heading for the biggest weekly jump since 2023.

Expectations for rate cuts have turned on their head, and the market is now expecting widespread hikes where it was predicting cuts before. Swaps contracts now expect a quarter-point rate increase by the European Central Bank this year, having previously priced the possibility of a further cut, and the most exposed governments in Asia are battening down the hatches.

Bond yields are already climbing as traders price in higher inflation that eats into the value of their coupon payments. In general the bonds of the world’s major energy producers are faring better than the importers as they expect a windfall from higher oil and gas prices.

With Europe falling into recession and the USA losing 92,000 jobs in February, traders had increased their expectation of several rate cuts this year to boost growth. However, following the “wild Monday” on the oil markets, inflation outlooks have sharply reversed.

The last major inflation shock was triggered by a 20-fold increase in prices in 2022, when Russia’s invasion of Ukraine sent global oil and gas prices soaring. Inflation in advanced economies was pushed to levels not seen for decades. European natural gas prices surged to more than ten-times their historical average, Brent crude briefly climbed above $120 a barrel, and electricity costs across Europe and parts of Asia followed suit.

The energy shock quickly spread through the wider economy as higher fuel and power prices raised transport costs, manufacturing inputs and food prices, pushing eurozone inflation above 10% and US inflation to 9.1%, the highest in four decades.

Central banks responded with the most aggressive tightening cycle since the 1980s, with the Federal Reserve, European Central Bank and others raised interest rates sharply to contain price pressures.

Offsetting that is the tendency of some central banks to “look through” a crisis and continue to cut rates despite rising inflation in order to counteract slowing economic growth. However, traders say that the global economy has not reached that point yet, the FT reported on March 9.

Timelines

Central banks have yet to react to the panic trading on energy markets, and upwards drift of oil and gas prices since the Straits of Hormuz was closed on March 2. As the war in the Middle East goes into its 11th day it's still early days and central bankers are sitting back to see what happens next.

Capital Economics outlined three possible scenarios in a recent note:

Scenario 1: Short, sharp conflict: In the most optimistic scenario, the conflict ends within weeks due to military defeat or internal pressure in Iran, similar to last year’s brief 12-day war. Attacks on shipping in the Strait of Hormuz would quickly cease, allowing Gulf energy exports to normalise. The disruption would remove around 350mn barrels of oil from global markets, roughly 1.4% of annual exports, with LNG flows hit by a similar proportion. Because the oil market is still expected to be in surplus this year – particularly as previously sanctioned Russian crude returns to market – prices would likely fall back quickly.

Scenario 2: Longer conflict, little infrastructure damage: A second scenario assumes fighting drags on for roughly three months, with Iran continuing attacks on shipping in the Strait of Hormuz and targeting US assets and civilian infrastructure in Gulf states. However, energy infrastructure in the region largely escapes serious damage and any disruptions are quickly repaired. Around 5–6% of global annual exports of crude and LNG could be temporarily lost, though exports would likely recover in the second half of 2026 once hostilities end.

Scenario 3: Prolonged conflict, major infrastructure damage: The most severe scenario envisages attacks spreading to key energy infrastructure across the Gulf, including major facilities such as Iran’s Kharg Island export terminal. This could cause lasting damage to production capacity in both Iran and neighbouring Gulf states, removing around 8% of global crude and LNG exports in 2026, with disruption likely continuing into 2027. The closest historical comparison would be the supply shock following the 1979 Iranian revolution and the Iran–Iraq war, though the shock today would occur over a far shorter timeframe, likely keeping oil prices in triple digits throughout 2026.

Who is exposed?

Countries that are big importers of oil and especially gas are the most exposed to an inflation shock also as a major exporter of both oil and gas. The conflict in the Middle East poses significant challenges for Asian economies, given that most are net energy importers.

US: America is in one of the best positions as it is a major energy exporter and so will be isolated from the worst of the swings in prices.

US inflation has eased significantly from its 2022 peak but remains slightly above the Federal Reserve’s 2% target. Headline consumer price inflation is currently running at around 2.8–3.0% year-on-year, while core inflation, which excludes food and energy, is slightly higher at roughly 3.1–3.3%. Bloomberg Economics calculated that $108 for a barrel of oil adds about 0.8 percentage point to inflation by year end, which when added to the pre-war forecast takes the forecast for inflation in the US to above 3%.

Economists were expecting inflation to continue gradually declining through 2026, and two to three rate cuts of around 25 basis points were expected. However, those expectations have now been flipped and at least two rate hikes are now forecast.

Asia: The most exposed economies are Korea, Japan, Taiwan and India, which source around half of their energy from the Gulf, but for inflation, the key channel is oil rather than LNG, says Capital Economics. The picture is complicated as the import of oil and LNG in particular, varies widely across the region and is also affected by the size of their energy buffers.

Pakistan, Taiwan and South Korea are most dependent on LNG from the Gulf. China and Japan are less vulnerable due to more diversified supply chains and alternative sources of energy as well as holding large strategic reserves. India sits in the middle: LNG from the Gulf represents a smaller share of overall energy consumption, but it is heavily dependent on fertiliser imports that are largely sourced from the Gulf.

“The impact on inflation will therefore mostly depend on what happens to oil prices. At around $85 per barrel, headline CPI would rise by just over 0.5 percentage points in most economies. This is manageable given inflation is currently within central bank targets. But if oil were to reach $100 per barrel, the effect would be more significant, lifting inflation by at least one percentage point and pushing it meaningfully above target in several economies. Thailand and China, which are in or near deflation, are the exceptions,” Capital Economics said in a note.

Most central banks will likely refrain from further rate cuts if oil prices stay high, with Thailand and China the exceptions given their deflationary backdrops, the analysts say.

Pakistan is amongst the most exposed as its imports of LNG come overwhelmingly from the Gulf; Pakistan usually imports 40% of its energy, and just over a quarter of that is in the form of LNG from Qatar. Domestic fuel prices have already jumped by 20% in just the last week.

Pakistan’s central bank kept rates on hold at 10.5% at a monetary policy meeting on March 9, but analysts say it will almost certainly be forced into at least two rate hikes this year as prices climb.

“Pakistan is one of the countries most threatened by the global energy shock because of its dependence on LNG from the Gulf, a recent history of very high inflation and balance of payments weaknesses,” Capital Economics said. “If global energy prices remain high and supply disrupted, it is likely to be forced to hike rates abruptly before long.”

Korea imports 4% of its gas needs from the Gulf. Headline inflation in Korea was 2.0% y/y in February, according to data published earlier today. But Korea also has significant exposure to rising energy prices as energy and transport account for around 10% of Korea’s CPI basket. If high LNG prices persist, some pass-through to electricity tariffs is almost inevitable, adding further pressure to headline inflation.

The government has in the past tried to cushion price spikes through temporary fuel tax cuts, the scope to offset higher oil prices is limited by the fiscal cost, meaning the pass-through to households and businesses tends to be relatively quick. A 10% increase in oil prices typically adds around 0.2-0.3 percentage points to inflation.

The saving grace is its larger storage capacity provides a partial buffer against short-term disruptions; Korea Gas Corporation alone has capacity to store a month’s peak demand, equivalent to 43 days of average daily demand, and its tanks are reportedly full.

India is relatively isolated with LNG from the Gulf making up 2% of energy supply. The government has invested heavily in renewables which have rapidly grown in its power mix and it still has a lot of legacy coal generating capacity that is in the process of being retired.

Japan has no gas production of its own and is very heavily dependent on imported LNG. But as it sources most of that gas under long-term contracts from partners including Malaysia, Australia and the US, it is also well insulated from the current crisis for now. Only 6% of Japan’s LNG imports, making up only 1% of overall energy supply, come from the Gulf. While Japan has eight-months-worth of oil in its strategic reserves, its storage for gas only holds enough to last 21 days.

Taiwan is also exposed, importing just over 7% of its gas needs from the Gulf. It also only has a thin buffer: the government has pledged to lift LNG inventories to 14-days’ worth of supply by the end of next year but isn’t there yet.

Singapore and Thailand, are better placed to contain the inflationary impact even if global energy prices remain elevated as they could relatively easily switch to alternative power sources such as coal.

China is a major oil and gas importer but thanks to its rapid diversification to green energy and its large strategic reserves, plus the ongoing imports of Russian oil and LNG, it is well insulated from the unfolding energy crisis.

China’s inflation remains very low, with consumer price inflation running at around 0.3–0.6% year-on-year and core inflation close to 1%, reflecting weak domestic demand, a struggling property sector and excess industrial capacity.

Economists expect inflation to edge higher during 2026, but not to more than 1.0–1.5%. With inflation well below levels seen in Western economies, the People’s Bank of China is likely to maintain an easing bias, potentially cutting rates or reducing banks’ reserve requirements to support growth rather than tightening policy.

Russia, Iran and Venezuela account for a substantial share of its purchases and — thanks to their pariah status — China was able to buy at deep discounts to the market price. If oil prices are $108 a barrel that would add about 0.8 percentage point to inflation but growth would take a modest hit.

GDP & Consumer Prices (% y/y)

Central bank policy rates

Europe: Europe is amongst the most exposed to the energy crisis. While it imports almost no gas directly from the Gulf, prices have almost doubled in just the first week of war and the EU suddenly finds itself in competition with Asia for the reduced supplies of LNG on the market – mostly supplied by the US and Russia.

Persistently high energy prices will complicate monetary policy for the European Central Bank. “The ECB may opt for one to two rate hikes if the conflict looks likely to be protracted and the impact more severe,” Oxford Economics said in a note.

Recent economic data had already shown renewed price pressures in the bloc. Eurozone inflation rose to 1.9% year-on-year in February, with core inflation at 2.4% and services inflation reaching 3.4%, driven in part by strong readings in France and Italy, according to Nicola Nobile, Chief Italy Economist at Oxford Economics.

Inflation in the eurozone was moderating, according to Eurostat, with headline consumer price inflation running at around 2.6–2.8% year-on-year in early 2026, down sharply from the peaks seen in 2022–23 but still slightly above the European Central Bank’s 2% target. Core inflation remains somewhat higher at roughly 2.7–3.0%, due to persistent services inflation and wage pressures.

Eurostat data show that energy prices remain a key source of volatility, as they were also in 2022, and the recent spike in global oil and gas prices linked to the Middle East conflict risks slowing the pace of disinflation. The ECB has acknowledged these risks but has said inflation is still expected to gradually return to target during the year, with many economists forecasting eurozone inflation to average around 2.2–2.5% in 2026.

The wild card in the European outlook is the battle of the bans. The EU’s position has been made even worse by its plan to ban imports of Russian gas entirely by the start of next year, with the first restrictions rolled out in April. Russian President Vladimir Putin is capitalising on the chaos and turned the tables on the EU saying if they didn't want Russian gas then Russia would cut the supplies that continue to arrive in Europe completely and sell them to “more reliable partners” in Asia.

Russia remains the fourth largest source of gas imports for the EU in 2025, and imports in 2025 actually increased as the EU struggled with the deep freezing this winter.

Europe is rapidly moving into a gas crisis caused by this winter's big freeze which has left its storage tanks at historically low levels. Asians are already outbidding Europe causing at least three LNG tankers destined for Europe to turn around to sail for better paying customers in Asia.

Bloomberg Economics’ model points to a blow to GDP from the energy shock of 0.6% for the euro area and 0.5% for the UK. Inflation also moves higher, with an upward impulse of about 1.1 percentage point for both economies. If expectations drift higher, the ECB and Bank of England may be forced to delay cuts or hike rates – compounding the blow to growth.