Dollar slides as energy shock pushes global central banks toward rate hikes

The dollar weakened this week as crude oil prices climbed sharply in the wake of military strikes on Iran, upending the calculus that central banks around the world use to set interest rates. What had seemed settled just weeks ago—that the Federal Reserve would cut rates twice in 2026—now looks unlikely. Meanwhile, the European Central Bank, Bank of England, Bank of Japan, and Reserve Bank of Australia are all signaling they may raise rates instead, a reversal that has sent currency traders scrambling to recalibrate their positions.

Before the U.S. and Israel began their campaign against Iran in late February, financial markets had priced in two Fed rate cuts for the year. The conflict changed that calculation almost immediately. Strikes on Iranian oil infrastructure have effectively closed the Strait of Hormuz and disrupted energy exports from the Middle East, sending Brent crude futures up roughly 50 percent. That surge in energy costs threatens to push inflation higher across the global economy, forcing policymakers to consider tightening monetary policy rather than loosening it.

The Fed itself held rates steady earlier in the week, as expected. Chair Jerome Powell acknowledged the uncertainty, saying it was premature to assess the full economic scope of the Middle East conflict. But the market's interpretation was clear: no cuts are coming soon, and possibly none at all this year. That message, combined with signals from other central banks that they are prepared to act, has weakened the dollar against nearly every major currency. The euro, yen, sterling, and Swiss franc all posted weekly gains. The dollar index—which measures the greenback against a basket of six major currencies—fell 0.86 percent for the week, its largest decline since late January.

The European Central Bank kept rates unchanged on Thursday but warned that energy-driven inflation posed a real threat. The Bank of England did the same, though its statement that it stood ready to act triggered a sharp sell-off in short-dated government bonds. The Bank of Japan, meanwhile, left the door open to a rate increase as soon as April, a signal that caught investors off guard and helped lift the yen. Australia's central bank went further, raising rates for the second time in two months, with markets now expecting additional hikes to follow.

On Friday itself, the dollar actually gained ground—the euro fell 0.39 percent to $1.15350, the yen weakened 0.85 percent to 159.07 per dollar, and sterling dropped 0.78 percent to $1.3325. But these daily moves obscured the larger weekly trend. Juan Perez, director of trading at Monex USA, noted that central banks sounded more confident about their ability to manage inflation than markets had anticipated, particularly the Bank of England and Bank of Japan. The Fed, by contrast, appears content to hold steady and watch how events unfold.

Analysts caution against reading too much into the dollar's weekly decline. Many expect the weakness to prove temporary, given the underlying economic fundamentals that typically support the greenback. But for now, the energy shock has redrawn the map of global monetary policy, leaving the Fed as the lone major central bank with no rate hikes on the horizon and the dollar paying the price for that isolation.