Major central banks are up against a very tough task in navigating monetary policy next

The central bank bonanza returns to town this week and will feature plenty of big names on the agenda. The BOJ, BOC, Fed, BOE, and ECB will be stepping up to the plate but are all expected to keep interest rates unchanged. The hot topic is the Middle East war and we are now officially nine weeks into that. And yet with all the talk of progress, the Strait of Hormuz remains closed and physical oil prices remain at lofty levels. Sure, the price we're seeing on our screens may be less alarming but the prices exchanged for physical barrels and what consumers are paying at the pumps are totally different. And it is very much the latter that is going to become a major issue for central banks. That especially if the status quo is prolonged and higher energy prices become more embedded into other parts of the economy. To keep things simple, central banks are very much considering raising interest rates now to counter surging inflation pressures from the jump in energy prices. Some are even already considering taking a more proactive step but have slowly peeled away from that now, although it has already shifted market expectations. This is what I don't like about it. Monetary policy is ill-equipped to tackle a supply shock and/or negative demand shock. And that is precisely what we are seeing now as oil and gas prices go through the roof. The feed through to inflation is driven by cost-push factors, something which central banks detest. Yet, they may still feel the need to act just because. It is their mantra to counter aggressive inflation expectations and to keep things in check. However, raising interest rates will not help do anything to resolve the situation with the Strait of Hormuz. It does nothing to stop the war in the Middle East and disruption to key energy facilities in the Gulf region. So, all this does is basically just double down on crushing demand as households struggle and increases the risks of economic stagnation or even a recession. That especially if the conflict continues to extend for a few more weeks/months. The toll faced by consumers and businesses are very much exponential to the timeline here. If policymakers are not careful and act too hastily, they might even risk triggering stagflationary pressures. And that would be a total disaster after having treaded the needle to carefully bring inflation pressures down after the Russia-Ukraine conflict back in 2021-22. That brings us to the second part of the whole issue though. It is that the early communication from central banks have already set the tone that they might feel the need to respond accordingly. Even if not explicit, moving away from the previous path of cutting interest rates to opening up the hawkish door is a strong enough signal. And that is seeing markets now move to price in a couple more rate hikes for the remainder of the year. The fear now is that if policymakers realise that monetary policy cannot solve the energy shock problem, what happens if they don't deliver on the necessary rate hikes? With how markets have positioned themselves in the past weeks, this will mean a loosening of financial conditions. That after markets have already done the work by tightening them in pricing in rate hikes. Credibility concerns aside, this is a potentially dangerous situation as it risks inflation running away especially if we start to see second-round effects come into play. That particular risk is what central banks are very much afraid of, even if the Middle East conflict is to end today. And the issue then becomes how much do they have to raise interest rates to deal with it? A quick example is the ECB having already cut its deposit facility rate to 2.00% coming into this year. And policymakers have gauged that the neutral range is seen somewhere around 1.75% to 2.25% roughly. So even with two 25 bps rate hikes, that will bring the deposit facility rate to 2.50%. That is just borderline above neutral and marginally restrictive. Is that really enough