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Federal Reserve chair Jay Powell has acknowledged that the Iran war will raise inflation as a fresh jump in oil prices sent short-term US borrowing costs to the highest level since last summer.
Powell said on Wednesday that in the near term, “higher energy prices will push up overall inflation, but it is too soon to know the scope and duration of the potential effects on the economy”.
His comments came as the US central bank left interest rates on hold at 3.5 to 3.75 per cent for the second meeting in a row, as policymakers balance concerns that the Middle East conflict will ignite a fresh burst of consumer price rises against a weakening labour market.
“The implications of events in the Middle East for the US economy are uncertain,” Powell said at a press conference.
A new set of economic forecasts showed that Fed officials are now expecting the central bank’s preferred PCE inflation rate will end the year at 2.7 per cent, above the 2.4 per cent they predicted in December. That would be well above the Fed’s 2 per cent inflation target.
Short-term US government bond yields, which are sensitive to rate expectations, rose sharply on Wednesday as the Fed upped its inflation outlook and US oil prices jumped to about $99 a barrel.
The yield on the two-year Treasury note jumped 0.1 percentage points to 3.77 per cent — the highest level since August 2025. Wall Street’s S&P 500 share index dropped 1.4 per cent.
Trading in federal funds futures suggests traders are anticipating the next Fed rate cut in July 2027, marking a stark change from before the Iran war began, when markets had been pencilling in as many as two cuts.
“Energy shocks are inflationary, which is negative for bonds across the board, and Powell’s comments today didn’t reassure anyone,” said Kathryn Kaminski, chief research strategist at investment group AlphaSimplex.
The shifts in Wall Street’s monetary policy expectations come as petrol and diesel prices have leapt higher in recent weeks, exerting a heavy toll on consumers and businesses in a country that relies heavily on driving for travel and transporting goods.
The projections released on Wednesday also showed that Fed officials still plan to cut rates by a quarter point this year, in line with their previous set of forecasts in December. Twelve of the 19 members of the Federal Open Market Committee predicted at least one cut, against seven who said rates would remain the same.
But Powell signalled not to read too much into the Fed’s current forecasts given the high degree of uncertainty over the Iran war.
“The thing I really want to emphasise is that nobody knows,” he said. “The economic effects could be bigger, they could be smaller, they could be much smaller or much bigger. We just don’t know.”
He indicated that “several” FOMC members had suggested the Fed’s next move could be to raise rates: “It did come up today.”
Fed governor Stephen Miran was the sole dissenter from the decision to hold borrowing costs for the second meeting in a row, with the ally of President Donald Trump backing a quarter-point cut.
The decision to hold borrowing costs was widely expected even before US oil prices jumped almost 50 per cent after the US and Israel’s first attacks on Iran on February 28.
The Iran conflict has left the Fed with a delicate balancing act over whether to prioritise its fight against price pressures over further signs of weakness in the US labour market.
The Bureau of Labor Statistics said the US lost 92,000 jobs last month, with several large companies announcing plans to lay off workers in recent weeks.
Meanwhile, economic growth cooled in the fourth quarter to an annualised rate of 0.7 per cent, well below the previous quarter’s 4.4 per cent growth rate.
The Fed’s projections on Wednesday showed that officials are expecting 2026 growth to come in at 2.4 per cent — compared with the December estimate of 2.3 per cent.
Separately, Powell said on Wednesday that he expects to remain on as Fed chair temporarily if Kevin Warsh, who Trump has nominated to succeed him in May, is not confirmed by the Senate by that time.
Powell added he had “no intention” of stepping down as a Fed governor before a Department of Justice probe over the $2.5bn refurbishment of the central bank’s headquarters in Washington was resolved and that he had not decided whether he would do so before his term expires in 2028.
“I have no intention of leaving the board until the investigation is well and truly over with transparency and finality,” Powell said. “On the question of whether I will then continue to serve as a governor after my term ends and after the investigation is over, I have not made that decision yet.”