The ghost of inflation at Azerbaijan’s borders Global shockwaves and local risks

The ongoing confrontation in the Persian Gulf, now in its third month, has significantly reshaped global economic trends. The blockade of the Strait of Hormuz has disrupted supply chains, driving up transportation and insurance costs, and, in turn, pushing energy prices higher. As a result, these developments have fuelled a global surge in imported inflation. In response, regulators in several countries have shifted towards more cautious monetary policies, often opting to raise key interest rates.

The effects of this negative trend are also being felt in Azerbaijan. Recently, the Central Bank of Azerbaijan (CBA) revised its inflation forecasts upwards. At the same time, it decided to keep the key interest rate and the parameters of the interest rate corridor unchanged.

Even before the outbreak of the “major war” in the Middle East, global analytical centres — including experts associated with the World Economic Forum (WEF) — had already noted serious contradictions undermining the cohesion of the world economy in 2025–2026. At the same time, tariff confrontation was identified as the most visible manifestation of geo-economic rivalry.

Taken together, these factors have contributed to a decline in global trade and investment, while supply chains and access to natural resources have weakened. In some cases, highly developed countries have introduced export restrictions on key goods, contracts have been cancelled, controls over capital flows have been tightened, and direct pressure has been exerted on the energy sectors of developing economies.

Against this backdrop of instability, the International Monetary Fund (IMF), in April of this year, revised its forecasts, lowering global economic growth expectations for 2026 by 0.3 percentage points compared to the previous year’s figure of 3.4%.

However, even more pessimistic than the IMF outlook are the projections of the World Bank and the European Bank for Reconstruction and Development, which anticipate a contraction in both external trade volumes and domestic demand in 2026, forecasting global GDP growth to fall to 2.6% and 2.3% respectively.

What is worse, the global economic slowdown this year is expected to be accompanied by rising inflation linked to developments in the Persian Gulf.

In particular, against the backdrop of the energy crisis and rising inflation risks, the period from January to April 2026 has seen a sustained global trend towards higher policy interest rates.

It is important to clarify that central banks adjust the policy (base) interest rate by setting the rate at which they lend to commercial banks. One of the key functions of interest rates is also to contain consumer inflation.

During periods of inflationary stability, and in order to stimulate economic activity or support recovery from recession, policy rates are typically lowered, increasing the flow of credit and investment into the economy. Conversely, in cases of financial overheating or external shocks that push consumer prices higher, interest rates are raised. In such conditions, they act as a brake on the money supply, reducing the flow of funds from banks and other sources into production, trade turnover, and other sectors of the economy.

Accordingly, due to the war in the Gulf, the Reserve Bank of Australia raised its key interest rate in February and continued its tightening cycle, reaching a level of 4.35%–4.6% by May. In turn, the Central Bank of the Philippines increased its policy rate by 25 basis points (one basis point = 0.01%) to 4.5% in April. Meanwhile, the Bank of Japan has signalled a rate increase from 0.75% to 1.25%–1.5% by the end of the current year as part of efforts to combat inflation.

The US Federal Reserve (Fed), in March–April 2026, decided to pause rate cuts, keeping the rate at 3.50%–3.75% and considering a possible near-term hike due to an anticipated “second wave” of inflation. The European Central Bank (ECB) is also considering a potential rate increase in June 2026.

Similar steps towards raising interest rates in the current year are also possible in countries facing high inflationary pressure, including Venezuela, Türkiye, Argentina, Nigeria, Zimbabwe, and others.

In Azerbaijan, no final decision has yet been made regarding a shift in the direction of monetary and, indirectly, macroprudential policy.

The policy (key) interest rate was last reduced in early February 2026 to 6.5%, while all parameters of the interest rate corridor were also lowered by 0.25 percentage points. More recently, the Central Bank of Azerbaijan (CBA) decided to keep the key rate unchanged. The lower bound of the interest rate corridor remains at 5.5%, while the upper bound stands at 7.5%.

The regulator has stated that the next decision on the policy rate and corridor parameters will be announced on June 24, taking into account changes in the inflation forecast as well as the results of macroeconomic analysis.

At present, it remains difficult to make firm assumptions about the regulator’s stance on the policy rate by mid-year. At the same time, IMF experts have recently recommended that the CBA raise the policy rate if inflationary pressures persist. The IMF forecasts inflation in Azerbaijan at around 6% in 2026.

Notably, in yesterday’s statement, the Central Bank of Azerbaijan also emphasized that rising geopolitical tensions worldwide have significantly strengthened the impact of external factors on inflation risks.

The key external risk is linked to the transmission effect of import prices on domestic inflation, whereby imported inflation primarily depends on price dynamics in Azerbaijan’s major trading partners. At the same time, the annual volatility of global energy commodity prices, as well as fluctuations in the nominal effective exchange rate, should not be overlooked.

“The conflict in the Middle East has disrupted supply chains, led to higher transportation and insurance costs, and increased volatility in global energy markets. The continuation of these processes until the end of the year will be one of the key factors determining inflation dynamics in Azerbaijan’s trading partner countries,” the regulator noted.

The Central Bank of Azerbaijan (CBA) also stated that international financial institutions have revised their global inflation forecasts for the current year upwards.

“In subsequent periods, external inflationary pressure will depend on inflation in Azerbaijan’s trading partner countries and the dynamics of the nominal effective exchange rate. One of the main internal risk factors also remains inflation expectations, which contribute to consumption growth above expected levels,” the CBA emphasized.

Against this backdrop, the CBA announced an upward revision of its inflation forecasts. Under the updated baseline scenario, inflation is projected at 5.9% in 2026 and 4.5% in 2027. For comparison, previous forecasts stood at 5.5% for 2026 and 4% for 2027, meaning the inflation outlook has been raised by 0.4 and 0.5 percentage points respectively.

It is also noted that annual core inflation in the current year stood at 5.5%. At the same time, the highest annual price growth — 6.5% — was recorded in food products, alcoholic beverages, and tobacco products. In paid services, the figure reached 5.7%, while in non-food goods it stood at 3.7%.

According to the May forecast, a significant part of inflation is expected to be driven by supply-side factors. At the same time, the regulator believes that under the baseline scenario, annual inflation will remain within the target range of 4 ± 2% in both the current and the following year.

As for other key macroeconomic indicators, the Central Bank notes that the country continues to maintain favourable external sector performance. According to customs statistics, in the first quarter of 2026, the positive foreign trade balance amounted to $1.4 billion, which is 93.3% higher than in January–March of the previous year.

The regulator also revised upwards its forecast for the current account surplus of the balance of payments, which is expected to reach $5.5 billion in 2026, compared to $3.5 billion last year.

A positive element of the current situation is also the steady growth of Azerbaijan’s strategic foreign exchange reserves. In January–April, they increased by $2.9 billion, rising by 3.4%, and reached a total of $88 billion.