LONDON, March 19 (Reuters) - Investors ramped up bets for interest rate hikes in Europe on Thursday before European Central Bank and Bank of England policy decisions, as the escalating U.S.-Israeli war with Iran pushed up energy prices and stoked inflation fears.
The Federal Reserve on Wednesday held rates steady, but forecast higher inflation this year than it had previously due to surging energy prices, clouding the rate outlook.
The Swiss and Swedish central banks both kept rates on hold on Thursday, but flagged inflation and growth risks from the war, amid a pivotal week of global central bank meetings.
Oil prices, trading at $115 a barrel , have jumped almost 55% this year and investors expect major central banks to be more responsive to higher energy prices than they have in the past, especially with the early 2020s inflationary shock fresh in the memory.
"Overall, I expect (central banks) to be more hawkish just because they have an inflation shock that's working its way through the system," said Franklin Templeton's head of European fixed income David Zahn.
"Our overall view is that this is definitely inflationary and this means the ECB will be hiking, probably this summer."
A renewed surge in energy prices overnight has pushed money market traders to price in over 55 basis points (bps) of ECB tightening by year-end, implying at least two quarter-point rate hikes.
The first rate hike is fully priced in by June. Prior to the conflict, investors had been pricing a small chance of a rate cut this year.
Markets had expected the BoE to lower rates this week as the labour market showed signs of weakening, before the war upended those bets. Markets now bet that the BoE will hike rates at least once in 2026.
For the Fed, investors now see just a 40% chance of a single rate cut this year. Before the conflict, markets had expected at least two quarter-point rate cuts.
BOND MARKETS ON EDGE
The hawkish global repricing has pushed up bond yields sharply, with the German and Italian economies particularly sensitive to rising energy costs.
Germany's two-year government bond yield , sensitive to changes in rate expectations, has jumped almost 50 basis points this month to its highest level since August 2024.
Britain's two-year yield touched its highest level in almost a year on Thursday at 4.282%. It's up over 70 bps since the start of the war.
The Reserve Bank of Australia raised its rate on Tuesday, warning of a "material" risk to inflation. It was the first major central bank to announce policy since the start of the Middle East conflict.
The Bank of Japan held rates steady on Thursday but warned of the impact rising oil could have on prices.
Reporting by Samuel Indyk and Yoruk Bahceli; editing by Dhara Ranasinghe, Alexandra Hudson
