WASHINGTON, March 18 (Reuters) - Rising concern about higher inflation from surging oil prices is not going to press the Federal Reserve into an interest rate hike this week, but the idea could still find its way to the surface at a policy meeting overshadowed by the start of the Iran conflict just over two weeks ago.
The rate-setting Federal Open Market Committee is universally expected to hold the policy rate steady in the 3.50%-3.75% range when members adjourn their two-day meeting on Wednesday.
Most investors and economists still see the next change in borrowing costs as a rate cut, but even that confidence has eroded since the U.S. and Israel launched an aerial assault on Tehran on February 28.
"We see a significant, underappreciated tail risk that the FOMC moves toward a 'symmetric policy bias,' i.e., either a rate hike or a cut is roughly equally likely to follow," economists at BNP Paribas wrote last week, voicing speculation that has cropped up with increasing frequency since the conflict brought around a fifth of the global oil trade to a halt.
Economists at Deutsche Bank put it more directly: "Could the Fed hike rates in 2026?"
Policymakers have a couple of ways to signal that potential.
The most explicit, though less likely, would be as a group, indicating in their policy statement due at 2 p.m. EDT (1800 GMT) Wednesday that their next move is just as likely to be an increase as a decrease.
More likely, though, the idea could surface in fresh quarterly economic projections, also due at 2 p.m., if one or more individual policymakers feel a rate hike may be in order this year or even next.
Doing so surely would draw fire from U.S. President Donald Trump, who continues to pressure Fed Chair Jerome Powell to lower interest rates.
The president has nominated former Fed Governor Kevin Warsh, whom Trump views as supportive of rate cuts, to take over from Powell when his Fed chair term ends mid-May, though hurdles to Warsh's ascension remain.
With inflation by the Fed's targeted metric running above its 2% target for five years now and counting, several U.S. central bankers wanted the option of a rate hike on the table even before hostilities in Iran sent the price of crude oil up by about 50% and U.S. gasoline prices sharply higher.
The oil price increase, seen as potentially feeding into higher prices more generally, led to a surge in financial market bets that central banks in other parts of the world more reliant on imported energy, including Europe and Asia, would need to respond with higher rates.
Meanwhile, traders have trimmed their bets on Fed rate cuts, and many Wall Street firms in recent days have torn up their forecasts for a Fed rate cut by June and say they see the Fed on hold for longer.
WATCHING FOR A STAGFLATIONARY LEAN IN NEW FORECASTS
The Fed could on Wednesday focus attention on a possible rate hike with a simple edit to its post-meeting statement: changing the reference to "additional" rate cuts that has been in the statement since the central bank kicked off a string of three reductions last September.
Still, the prevailing view is that it would be hard for oil prices to worm their way into the vast U.S. economic engine deeply and quickly enough to reverse an expected downward trend in inflation for later this year as the effect of last year's tariff shock wears off.
That leaves a rate hike this year a doubtful prospect, and makes it less likely that Fed policymakers collectively crack that door open this week.
"Our base case is that policymakers delay this change for now, as the U.S. labor market does not seem to be overheating and the war’s length, severity and economic impact are uncertain," the BNP Paribas economists wrote.
Central bankers are customarily resistant to reacting to potentially short-lived commodity price spikes. They also likely harbor continued worries about labor market resilience, especially after employers unexpectedly shed jobs last month. Higher oil prices could also slow the economy if consumers pare back on other spending as they allocate more money to each tank of gas.
So analysts generally expect most Fed policymakers to project at least one interest-rate cut this year. At least one - Fed Governor Stephen Miran - is expected to dissent on Wednesday, preferring an immediate cut over waiting.
A survey of former Fed policymakers and staff was a bit more hawkish. In the survey, run by Duke University visiting scholar and former Wall Street Journal reporter John Hilsenrath, 13 of 27 respondents said the Fed should hold rates steady all year, and six called for raising rates. Only eight thought cutting rates would be appropriate.
Overall, central bankers are expected to pencil in higher inflation for this year than they had expected in December, the last time they issued projections, but they are also seen as likely to write down higher unemployment and slower growth.
That unhappy remix in forecasts - a lean in what Chicago Fed President Austan Goolsbee calls a "stagflationary direction" because it suggests both a stagnating economy and inflationary prices - means that Fed policymakers likely remain deeply divided on which problem is likely to require action first.
The so-called "dot plot" of Fed rate path expectations may show how extreme the division is, and could include one or more policymakers writing in a higher policy rate at year-end.
"Those dissenting in favor of rate cuts will pencil in more cuts for the rest of the year, while we could see some of the more hawkish participants in the meeting pencil in a rate hike," KPMG economist Diane Swonk said. "Tension between the Fed’s dual mandate of fostering price stability and full employment will be reflected in participant rate projections. "
(Reporting by Ann Saphir and Howard Schneider; Editing by Andrea Ricci)
