Economists suggest tighter monetary policy in view of Middle East war

Highlights:

• Iran conflict drives global oil, gas prices sharply higher
• Bangladesh fears higher inflation, interest rates, weaker business confidence
• Economists urge tight monetary policy and protecting foreign exchange reserves
• Taka depreciation possible as import costs and dollar demand rise
• Government borrowing may increase amid higher energy import bills
• Central bank warned to avoid stagflation during global supply shock

Amid the ongoing war in the Middle East, economists have suggested continuing tight monetary policy and protecting foreign exchange reserves.

The surge in global gas and oil prices following the US and Israeli attacks on Iran has raised fears that the conflict could push up inflation and interest rates in Bangladesh, weighing on business confidence.

Bangladesh Bank held a special consultation meeting with economists yesterday to assess the war's potential impact, where four major issues were highlighted: foreign exchange reserves, the exchange rate, inflation and the monetary policy stance, according to meeting sources.

The economists feared the central bank may need to adjust the exchange rate by depreciating the taka amid rising import costs, which could directly push up inflation that remained sticky above 8.5% in January.

In this situation, they suggested continuing tight monetary policy and protecting foreign exchange reserves, said Fahmida Khatun, executive director of the Centre for Policy Dialogue (CPD), who attended the meeting.

The meeting was attended by M Masrur Reaz, chairman and CEO of Policy Exchange; Mustafizur Rahman, distinguished fellow at the CPD; Mustafa K Mujeri, executive director of the Institute for Inclusive Finance and Development; AK Enamul Haque, director general of the Bangladesh Institute of Development Studies; and Selim Raihan, executive director of the Sanem, among others, according to sources.

Infograph: TBS

At the meeting, the economists added that the scale of the crisis remains uncertain. However, if it evolves into a broader global disruption, pressure on reserves and the dollar market is likely to intensify.

Once the immediate pressures ease, the central bank may consider lowering interest rates to support investment and stimulate economic activity, they added.

At present, the exchange rate remains stable at Tk122.30-123 over the past six months, while reserves stands at over $30.36 billion as of 26 February, enough to cover imports for more than four months.

'Cenbank preparing for large demand for dollars'

Speaking to The Business Standard, a senior central bank executive, requesting anonymity, said the central bank is preparing for a large demand for dollars from the government due to the surge in oil prices.

The central bank may need to spend a significant amount from its reserves or buy dollars from the market to meet government demand, he said. "The only way to sustain reserves in this situation is to adjust the exchange rate, which will further fuel inflation," he added.

Rising import costs may also create fiscal pressure, and a government already facing a funding crisis may need to borrow more if the war prolongs, which could ultimately push up interest rates.

Bangladesh Bank has already backtracked from its earlier stance of reducing the policy rate amid strong negative reactions in the market, sources said.

The Iran war comes at a time when the country is already experiencing sluggish business activity, with private sector credit growth at a historic low of 6% and inflation above 8.5% in January.

'Policy rate shouldn't be cut by any means right now'

Speaking to The Business Standard, Md Ezazul Islam, director general of the Bangladesh Institute of Bank Management (BIBM), said a surge in oil prices would have a direct impact on imported inflation.

He said the war has already created global macroeconomic imbalances due to supply chain disruptions.

"So, the policy rate should not be cut by any means right now. Rather, the central bank must focus on containing inflation at least at the current level," said Ezazul, who previously worked with monetary policy as an executive director of Bangladesh Bank.

He added that persistently high inflation discourages foreign investment, as investors closely consider inflation trends before committing funds.

Moreover, the government will need more money to meet rising import costs, which may squeeze liquidity in the market and raise interest rates on treasury bills and bonds, he said.

He said the new government had been planning to create a business-friendly environment to boost production, while the central bank had been considering a policy rate cut.

However, business growth cannot be achieved through monetary policy intervention alone by reducing lending rates, he said.

"The government will have to adopt fiscal policy measures, including increasing development spending, to stimulate growth," he added.

Caution against stagflation

In the conventional monetary approach, central banks often adopt expansionary monetary policy during global crises to stimulate growth.

However, this approach proved problematic during the oil crisis of the 1970s, when it contributed to stagflation, said a senior Bangladesh Bank executive involved in research. Stagflation refers to the simultaneous occurrence of slow economic growth, high unemployment and rising prices.

The executive said that during a global supply shock, output declines while inflation rises. In the modern policy approach, central banks often adopt contractionary monetary policy during global crises to contain inflation expectations, he added.

"Now it depends on the central bank's strategy – whether it prioritises output or inflation," he said. However, he suggested the central bank should remain cautious to avoid the risk of stagflation.

First identified in the 1960s, stagflation challenged long-held economic theories when it emerged most dramatically during the oil crisis of the 1970s.

Decades later, in April 2025, Federal Reserve Chair Jerome Powell warned that the Trump administration's new tariffs were "significantly larger than expected", with likely effects including "higher inflation and slower growth" – classic precursors to stagflation.

How global central banks may react to the Iran war

Global central banks may delay policy rate cuts as they monitor how long the war continues, according to international media reports.

Subitha Subramaniam, chief economist and head of investment strategy at Sarasin & Partners, said if oil prices remain high for a sustained period, "it will start to cascade into other prices such as food, agriculture and industrial commodities, and that's going to bleed into inflation".

The pace of inflation has been easing in the UK, prompting the Bank of England to cut interest rates earlier. However, Subramaniam suggested the Bank may keep interest rates unchanged at 3.75% for now, despite earlier signals that further cuts could follow.

Federal Reserve Bank of Minneapolis President Neel Kashkari said on Tuesday that he had "a lot of confidence" in the US economic outlook before Washington launched attacks on Iran, but noted uncertainty over interest rate cuts.

He said it was "too soon" to estimate the conflict's impact on inflation, adding that much would depend on how long and how severe the war becomes.

Kashkari's view echoed comments from Federal Reserve Bank of Cleveland President Beth Hammack, who told The New York Times that it was too early to gauge the conflict's impact on inflation.

Global energy prices have risen sharply since the US and Israeli attacks on Iran. Oil prices have increased roughly 10-13% immediately after the escalation. In the following days, oil prices surged around 18-25%, with Brent climbing above $90 per barrel, the highest level in more than a year.

Natural gas prices have been even more volatile. European gas prices jumped up to 40-45% amid supply disruptions and attacks affecting LNG facilities and shipping routes. In some markets the surge has been steeper due to logistical disruptions, according to media reports. 

If the conflict disrupts Gulf exports for a prolonged period, analysts warn oil prices could rise toward $100–$150 per barrel, which would significantly increase global inflation pressures.