Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable Asset Management, discusses the state of oil prices and the impact on central banks.
Oil prices fell sharply to pre-war levels after the announcement of the US-Iran Memorandum of Understanding in mid-June. As we argued last week, we thought supply and demand dynamics would push prices higher, with Brent settling around $75-80 a barrel by year end. Renewed tensions, however, have already vindicated that view, lifting prices into the projected range.
Assuming prices remain at those levels, headline inflation should remain relatively elevated this year but ease again next year, as energy begins to subtract from inflation. Just as important, there is little evidence so far of meaningful second-round effects. Some are likely to emerge later this year, but at this point the pressure to tighten monetary policy has, in our view, receded.
US domestic conditions point towards higher policy rates
For the Fed, however, the story is different. It was never likely to tighten policy solely because of higher energy prices. Nor should lower oil prices be enough to push it in a more dovish direction. Instead, domestic conditions will determine the path of policy. In our view, those conditions increasingly point towards tighter monetary policy.
Unemployment should fall further
The labour market has strengthened markedly since last year. Although the economy barely created any jobs in 2025, payrolls rose by an average of 92,000 a month in the first half of this year. The unemployment rate has consequently fallen from a peak of 4.5% in November to 4.2% in June, while the ratio of vacancies to unemployed workers has risen from 0.88 to 1.04.
Admittedly, June’s decline in unemployment partly reflects a sharp fall in prime-age labour-force participation and may therefore prove temporary. Even so, we expect labour-market conditions to tighten further. With labour-supply growth close to zero, only modest job creation is needed to keep unemployment stable. Lower trade uncertainty, the ongoing AI-capex boom and the lagged effects of looser fiscal policy should keep employment growth positive, weighing on the unemployment rate.
Underlying inflationary pressures are building up
Wage growth remains broadly consistent with stable inflation. Yet we wouldn’t be surprised if wages accelerated more quickly than usual. Tight migration policy has probably made labour supply more inelastic. At the same time, underlying inflation remains too elevated, with core CPI and core PCE inflation running at 2.8% and 3.4% year -on-year respectively.
Survey indicators, including the ISM services index, suggest inflationary pressures may intensify further. As we have argued before, we are sceptical that AI will prove deflationary in the short term. If anything, it is currently adding to inflation through higher demand for electricity, materials to build data centres and computing equipment.
We now expect two Fed hikes
We have therefore revised our Fed outlook. We now expect two rate increases: one in the fourth quarter of this year and another one in the first quarter of next year, rather than a prolonged pause. History suggests that the US labour market can develop considerable momentum once it begins tightening. The risk is that the Fed ultimately has to do more. We have also raised our GDP growth forecast for this year to 2.2%, from 2.0%, while we lowered our inflation forecast to 3.5%, from 3.7%, reflecting lower oil prices.
Europe to benefit if Strait of Hormuz stays open
The euro-area economy remains heavily dependent on imported energy. The oil -price spike that followed the closure of the Strait of Hormuz therefore dealt a significant blow to industry and weighed on the euro. Although the durability of the ceasefire remains uncertain at the time of writing, oil prices appear to have retreated from their second-quarter peak and are likely to settle at around $80 a barrel.
That would leave the euro area benefiting from a combination of lower energy costs and a weaker exchange rate. Meanwhile, Germany’s fiscal expansion is gradually gaining traction, most visibly through higher defence. Industrial production is expected to strengthen in the coming months, in line with the recent improvement in manufacturing orders.
Euro area inflation to stabilise
Inflation fell to 2.8% year on year in June, from 3.2% in May, largely because of lower oil prices. Core inflation eased to 2.4%, while services inflation fell to 3.2%. We expect headline inflation to remain close to 3% for the rest of the year. For monetary policy, the key question is how much of the energy shock has already passed through to prices.
Higher energy costs are likely to raise intermediate input prices across many sectors and, crucially, put upward pressure on food prices. There is also a risk that inflation expectations rise, at least temporarily, triggering second-round effects through stronger wage settlements. A weaker euro will add further pressure via higher import prices.
The ECB will retain a tightening bias
Against this backdrop, we expect the ECB to retain a tightening bias. Another rate increase in the second half of the year remains our base case, with September the most likely, though the timing is far from certain. Admittedly, the ECB is likely to revise down its inflation forecasts, particularly for this year. Its current projection of 3.0% inflation was based on the assumption that oil prices would average $112 a barrel in the second quarter. A downward revision towards our forecast of 2.6% this year and 2.3% next year could make a September rate increase more difficult to justify.
Bank of England unlikely to raise rates this year
The UK economy remains fragile. High-frequency indicators suggest activity stagnated in the second quarter, while unemployment has drifted higher. The good news is that inflation has surprised on the downside for two consecutive months. With oil prices well below the assumptions used in the Bank of England’s April Monetary Report and household inflation expectations easing, the risk of second-round effects has diminished. We therefore no longer expect the Bank to raise rates this year and instead foresee Bank Rate remaining at 3.75%.
