Diverging Interest Rate Outlooks in the U.S. and Europe
When the conflict in the Middle East erupted, several assumptions quickly gained broad acceptance:
- If the Strait of Hormuz were to remain closed for several months, oil prices would continue to rise sharply as genuine physical supply shortages emerged. Under this scenario, many analysts projected oil prices could reach between $150 and $200 per barrel.
- Rising oil prices would fuel inflation and, consequently, lead to higher interest rates. At the same time, economic growth would slow significantly, prompting increasing discussion of stagflation.
- However, market sentiment gradually shifted. More investors came to believe that neither the United States nor Iran had an interest in prolonging the conflict indefinitely, leading to expectations of a near-term agreement and the reopening of the Strait of Hormuz.
As a result, oil prices initially surged to approximately $130 per barrel before retreating to around $95.
A key factor now coming into focus is that many experts continue to predict that if the Strait of Hormuz remains closed for several more weeks or months, physical supply shortages will eventually emerge, pushing oil prices substantially higher. By extension, this would also place upward pressure on interest rates.
It increasingly appears that an agreement between the United States and Iran is becoming less likely, suggesting that the Strait of Hormuz may remain closed to commercial shipping for some time. Under such circumstances, a renewed increase in oil prices—and consequently interest rates—would seem entirely plausible.
Yet this has not occurred so far. In fact, oil prices have declined slightly. Does this mean that experts have once again misjudged the timing of potential supply shortages?
Most likely, they have underestimated the factors delaying the emergence of physical shortages:
- China, a major importer of Middle Eastern oil, has significantly reduced its oil imports in recent months, likely because it accumulated substantial inventories when prices were much lower. Rather than purchasing expensive new supplies, China is currently drawing down these existing stockpiles.
- U.S. oil production has increased, and the country is now exporting considerable volumes of oil.
- Gulf states have developed alternative export routes for their oil.
- Consumers have responded strongly to higher prices by reducing their consumption of oil and petroleum products.
What Does This Mean for the Future?
Oil inventories continue to decline, indicating that available reserves are gradually being depleted. While this process may take several more weeks or even months, it merely postpones the inevitable.
If the Strait of Hormuz remains closed, the loss of supply cannot be fully offset by the factors outlined above. Furthermore, once additional oil becomes available, inventories will need to be replenished—likely to levels higher than before for strategic and security reasons. As a result, a significant decline in oil demand is unlikely.
In short, as long as the Strait of Hormuz remains closed, oil prices are expected to remain elevated and may rise further. Meaningful downside in oil prices can only reasonably be expected if the Strait reopens in the near future. Even then, any subsequent price decline is likely to be gradual due to the anticipated rebuilding of inventories.
How Will Interest Rates Respond Under Different Scenarios?
As discussed in our recent reports, we consider a significant increase in oil prices over the coming period to be the most likely scenario. Given that the U.S. economy continues to grow at a reasonably healthy pace, substantial secondary inflationary effects are likely to emerge.
In this environment, the Federal Reserve may need to begin raising interest rates as early as July in order to keep inflation expectations under control.
Europe, however, faces a different situation. Economic growth remains considerably weaker, partly because Europe—unlike the United States—is heavily dependent on imported oil. In addition, the current AI-driven investment boom is concentrated primarily in the U.S. and China. Consequently, Europe is likely to experience fewer secondary inflationary effects and less upward pressure on prices.
We therefore expect the European Central Bank (ECB) to raise rates by 25 basis points this month, but even in a higher oil-price environment, we do not anticipate substantial additional rate increases thereafter.
Given the likely slowdown in economic growth resulting from higher oil prices, it is entirely possible that interest rates will be reduced again in 2027. In the United States, however, this scenario would imply not only further rate hikes but also a more limited scope for subsequent rate cuts.
What If Oil Prices Decline Following a Rapid Reopening of the Strait of Hormuz?
Should the Strait reopen quickly, leading to lower oil prices, inflation would likely ease while economic growth accelerates in both Europe and the United States.
In Europe, given current unemployment levels and available spare capacity within the corporate sector, stronger growth would not significantly hinder the disinflationary process. Interest rates would therefore likely remain under downward pressure for some time.
The situation in the United States is different. The investment boom is expected to continue, and the labor market is already relatively tight. Stronger economic growth would therefore translate fairly quickly into upward pressure on wages and inflation, unless productivity growth were to accelerate substantially—an outcome we do not currently anticipate.
As a result, a decline in oil prices could initially lead to lower interest rates in the United States, but rates would likely begin rising again relatively quickly thereafter (see also our recent GFM report).
