Heightened energy prices because of the US-Israel war with Iran has pushed US inflation to a three-year high.

The United States Federal Reserve will hold interest rates steady at 3.5 to 3.75 percent amid heightened inflationary pressures on the US economy.

The central bank announced the decision, which was unanimous, on Wednesday following its first two-day policy meeting under the leadership of Kevin Warsh, who took over the job of governor from Jerome Powell last month.

“Economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East,” the Fed said in a news release.

“Inflation remains elevated relative to the Committee’s 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy,” it added.

The decision was in line with expectations. CME FedWatch, which tracks the likelihood of monetary policy decisions, said there was a 99 percent chance that rates would remain unchanged.

Inflationary pressures loom

Inflation hit 4.2 percent last week, marking a three-year high, data from the consumer price index report from the US Labor Department — a key gauge the central bank uses to track inflation – showed.

That was driven primarily by heightened energy prices, which jumped 23.5 percent in May. However, news of a looming peace deal that could end the war between the US and Iran and reopen the Strait of Hormuz has driven down oil prices in recent days, with prices falling to a three-month low earlier this week.

However, even if the Strait opens soon, supply chain bottlenecks, energy production halts, and depleted fuel stockpiles mean it could be months before energy prices for consumers return to pre-war levels.

The months ahead

In early December, US President Donald Trump claimed that he would only appoint someone to lead the central bank if they agreed with him on interest rate cuts, but rising inflation due to heightened energy costs amid tensions between the US and Iran has changed the equation.

Trump has shifted his focus to opposing any rate increases.

On NBC’s Sunday political programme Meet The Press, Trump praised Warsh, but stressed that “there’s no reason to raise rates.”

“Even if Warsh feels beholden to the Trump administration, an overtly dovish tone would re-ignite concerns about Fed independence and risk pushing up long-end bond yields [which could raise borrowing costs]. Accordingly, a Trump-friendly Warsh would probably still try to toe the line between sounding neutral and acknowledging that hikes are a possibility,” Stephen Brown, Capital Economics chief economist for North America, said in a note.

While rates were maintained for this policy meeting, CME FedWatch forecasts that this will change in the months to come. By September, the tracker forecasts a roughly 30 percent probability of rate hikes; by December, there is a more than 50 percent probability if current conditions in the labour and financial markets stay in line with current forecasts.

Capital Economics forecasts a rate hike in December 2027 and another early in 2027. Goldman Sachs forecasts that the central bank will probably not cut rates until mid- to late 2027.