Monetary policy enters the era of geopolitical instability

The tensions in the Middle East now go beyond military and energy fields. By spreading to interest rates, financing conditions, and the real economy, they are profoundly transforming the actions of central banks.

Strong volatilities observed in financial and commodity markets reveal the emergence of a new sustainable regime, where geopolitics becomes a major determinant of monetary policy.

By Luc d’Anterroches, Associate at Financial Services BearingPoint.

For eighteen months, central banks believed they had regained control. The slowdown in inflation, the emergence of relatively clear deflationary trajectories, and the return of more predictable models hinted at a gradual normalization. This fragile yet coherent sequence has now been shattered.

The shock is not endogenous. It does not stem from demand escalation or a classic supply imbalance. It is geopolitical. And it fundamentally alters the analytical frameworks on which monetary policy is based.

The Middle East is currently at its epicenter. But what is changing is not just the resurgence of an energy risk: it is its direct integration into long-term macroeconomic expectations. The European Central Bank provides a particularly clear illustration. In March, it raised its inflation projections to 2.6% in 2026 in its central scenario, with a risk of reaching 3.5% to 4.4% in case of sustained tensions in the Strait of Hormuz. This range does not reflect mere conjunctural uncertainty. It marks a shift: geopolitics becomes a structuring variable.

This change in nature is crucial. For years, energy shocks were treated as external, transitory disturbances, whose effects could largely be offset by monetary action. This framework is now falling apart. Energy-related price increases are no longer limited to raw materials: they spread, settle, and transform.

The transmission channels are now well identified. Transport, insurance, and logistics costs are increasing sustainably. Supply chains are adjusting under constraint. And above all, these tensions end up irrigating services and wages, with potentially nonlinear propagation effects. The inflationary episode of 2021-2022 provided a glimpse of this. It may not have been an anomaly, but a precedent.

But the shock’s diffusion does not stop in the productive sphere. It now extends into the financial sphere through a more discreet yet equally decisive channel: interest rates. The rise in bond yields, fueled by geopolitical uncertainty and tensions over energy, is now transmitted to the financing conditions of the economy. Mortgage credit offers a concrete illustration: as rates rise, households’ purchasing power contracts, weighing on demand and, ultimately, on activity.

In this context, second-round effects become central in the reaction function of central banks. The question is no longer just about whether a shock is temporary, but whether it will anchor in expectations, financial conditions, and economic behaviors.

Bond markets are the first to incorporate this regime change. The idea of a sustained stabilization of key rates is fading. The ECB emphasizes that it could tighten policy if inflation remains persistently above its target, even when the shock is external. As a result, expectations become more volatile, more sensitive to geopolitical events than to mere macroeconomic indicators.

For banks, this evolution poses a unique challenge. While their direct exposure to the region is limited and their capitalization level is high, the main risk lies in the rapid and uncertain revaluation of their assets, in an environment where rate expectations can be abruptly revised. Bank balance sheets thus become immediate transmission zones for geopolitical shocks.

This is the paradox of the current situation: the financial system is generally solid, but it operates in an increasingly unstable environment. Infrastructure holds, markets absorb shocks, banks resist. Yet this resilience does not guarantee the system’s stability over time, nor the ability of economic actors to adapt to recurrent shocks.

Because the stake goes well beyond the banking or monetary sphere. What is emerging is a change in the economic regime. The global economy is entering a phase where geopolitical constraints become permanent. A few strategic transit zones are now sufficient to reshape inflation trajectories, adjust expectations, and redefine macroeconomic balances.

In such an environment, monetary policy can no longer operate according to familiar norms. The 2010s established a regime of low inflation and low volatility, conducive to largely predictable policies. The emerging period could be one of structural instability, where central banks must deal with recurrent, difficult-to-model exogenous shocks.

Hence, the central question is no longer just about the next rate move. It revolves around the profound transformation of the central banks’ reaction function. How to steer price stability when inflation drivers are partly beyond the traditional economic field?

This is the true tipping point. Monetary policy is no longer written solely in Frankfurt, Washington, or London. It also indirectly unfolds in tension zones, in Tehran, Muscat, and in the corridors of the Strait of Hormuz.

(*) Luc d’Anterroches is an Associate at BearingPoint, where he develops the company’s activities in financial services, focusing on asset and wealth management. He coordinates European offices and supports Solutions teams as well as BearingPoint Capital. Since 2006, he has been guiding banks, insurers, and asset managers in their major transformations. He also contributed to the international expansion of BearingPoint, strengthening the Financial Services practice in Singapore in 2012 and participating in the opening of the Dubai office in 2014.