Central banks have good reason to sit up and take notice of how this month’s oil shock is hitting inflation expectations. Yet financial market pricing shows a split picture so far. It looks like a one-two punch: a near-term cost-of-living burst that subsides again over the longer term.

The core debate in a week packed with major monetary policy meetings is whether an inflation spurt warrants interest rate rises – or whether central banks should treat the Iran-related energy supply shock as temporary and focus instead on its parallel drag on demand.

The only way to gauge if this inflation burst endures is to monitor expectations of investors, businesses and households. If those expectations climb with oil, it signals the main economic actors doubt central banks can or will contain inflation. That doubt then feeds so-called “second-round effects” – higher wage demands, firmer pricing by companies, and inflation that becomes more self-sustaining.

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If an inflation loop takes hold, central banks may be forced to bare their claws to prove otherwise.

Those concerns are already building less than three weeks into the Iran conflict. Crude, at about US$100 a barrel, is up almost 70 per cent this year and nearly 50 per cent from a year ago. U.S. gasoline pump prices have risen about 25 per cent over the past 12 months and are still climbing.

The key question now is how much of this will prove fleeting.

Inflation was already running hot in the U.S. and elsewhere before the Gulf crisis. And while March inflation data have yet to capture the full oil surge, financial market fears of a renewed spurt in headline inflation have intensified.

Bank of America’s monthly global fund manager survey, conducted between March 6 and 12, shows the mood shifting sharply.

A net 45 per cent of asset managers expect higher global inflation over the next year – compared with just 9 per cent a month ago. Less than a fifth now expect lower interest rates ahead – the lowest reading in three years.

Financial market pricing reflects this shift.

The U.S. one-year inflation swap, which prices in expected spot consumer price inflation, has surged to 3 per cent for the first time since last October. This is almost a point higher than it was at the start of this year and above the Fed’s target. That swap curve does not fall back below 2.5 per cent for five years.

Expectations embedded in the inflation-protected Treasury bond market have also picked up notably. The so-called “breakeven” inflation assumption built into those five-year notes has climbed more than 20 basis points to 2.65 per cent, its highest level in more than a year.

The pattern repeats across the G7. Five-year market inflation expectations have risen markedly, aggravated by this month’s 60-per-cent surge in natural gas prices, to which European economies are especially exposed.

Just over two weeks into the oil spike, we still have no comprehensive survey of U.S. consumer inflation expectations for the period since the conflict began.

The University of Michigan’s preliminary monthly poll did show some stability in one- and five-year inflation outlooks among households. But only half of the interviews in its Feb. 17-March 9 window were conducted after the Iran attacks. Even so, those expectations remained above 3 per cent across the horizon.

The New York Fed’s February survey, meanwhile, showed one-to-five-year inflation expectations gravitating to 3 per cent before the oil price spike.

So while the market view out to five years looks already concerning – and should worry central banks – it’s not a complete picture.

Look beyond five years, and the anxiety fades.

One market measure used to capture the 10-year horizon – the five-year, five-year forward inflation swap – has actually declined since the crisis started. At 2.35 per cent, it is now at its lowest level in almost a year.

Whether that reflects a longer-term demand hit from higher energy prices overwhelming the near-term inflation surge -or simply an assumption that central banks will eventually tighten hard – is unclear.

Either way, it points to a further inversion of the inflation curve – echoing the flattening of the Treasury yield curve in recent weeks.

Whether that curve reversal signals darkening recession clouds is a question that may loom larger over the months ahead.