Soaring energy prices and a rapid expansion in artificial intelligence spending are rekindling investor anxieties over inflation.

At the start of the week, violent conflict in the Middle East escalated. By the end, oil prices had surged past $100 per barrel, a move set to increase costs across global supply chains.

These three potential price-driving forces are hitting the global economy at a sensitive moment, just as central bankers saw signs of easing inflation. The situation has now reversed.

From the US Federal Reserve to the Bank of England, policymakers will need to quickly assess these new risks ahead of their decisions next week. While no immediate interest rate adjustments are expected, financial market anxiety about inflation now looks likely to persist throughout the summer. Global bond yields have spiked, a clear sign that investors worry consumer prices might spiral out of control. In equity markets, the S&P 500 is on track for a second consecutive weekly decline.

"Recent events are a reminder that geopolitics drives the economy, not the other way around," said Katharine Neiss, Chief European Economist at PGIM. "The pressure from negative supply shocks on headline inflation will continue to support a hawkish stance from central banks."

"Massive Attack"

This new energy shock comes as the Middle East conflict expands from the Strait of Hormuz to the Red Sea. Former President Donald Trump has indicated he is considering a "massive attack" on Iran to force the country into peace negotiations. Against this backdrop, crude oil prices broke through $100 a barrel for the first time in two months on Thursday, and natural gas prices also rose sharply.

Inflation risks, coupled with related fiscal concerns, point to significant bond price declines. Among various market movements, UK gilt yields recorded their longest stretch of closing above 5% in nearly 20 years. The 30-year US Treasury yield is just shy of its highest level since 2007.

The danger of rising oil and gas prices is their rapid transmission to consumer costs. ECB President Christine Lagarde warned on Thursday, "The energy shock could intensify further. The longer energy prices remain high, the more likely they are to push up broader inflation." She acknowledged that some colleagues questioned whether an immediate rate hike was necessary, but the ECB ultimately decided to hold steady. According to sources, the ECB is prepared to raise rates in September if the inflation outlook does not improve.

Meanwhile, evidence of massive investment in artificial intelligence continues to emerge. On Thursday, Alphabet Inc. raised its capital expenditure forecast for this year to as high as $205 billion. Signs of pricing power among large corporations are also fueling some concerns. Last month, Apple Inc. raised prices across its Mac, iPad, home devices, and Vision Pro to offset rising input costs from an unprecedented shortage of memory chips and storage.

Kamakshya Trivedi, Head of Global FX and Emerging Markets Strategy at Goldman Sachs, expressed concern over both the energy shock and technology spending. "I'm more worried about the inflationary push coming from the energy sector right now. I think that's a factor we need to watch. Over the longer term, the bigger factor is AI capital expenditure, and changes in how the market views this factor will, I think, be a key force driving reactions across various markets," he said.

All these re-emerging inflation considerations will influence upcoming discussions among monetary policymakers in the G7 and beyond. The US Federal Reserve's meeting results are due Wednesday, followed by decisions from the Bank of England and the Bank of Japan. Sources indicated earlier this week that Japanese policymakers are open to accelerating the pace of rate hikes. Data released on Friday showed Japan's inflation gauge rose for the first time in three months.

In the US, economists still expect the Fed's next move to be a rate cut, even as financial markets are betting on rising borrowing costs. The market has fully priced in one rate hike by the Fed by September. The central banks meeting next week will not convene again until the latter half of next month, meaning their signals could set the tone for the coming weeks.

Emanuel Moench, a professor at Frankfurt School of Finance & Management and a former Bundesbank official, commented, "While the ECB has decided to hold steady for now, the pressure for further rate hikes this autumn has undoubtedly increased. The Fed will likely also keep rates unchanged next week, but the case for an autumn rate cut has almost completely disappeared."