The investment bank expects the Federal Reserve to raise interest rates by 25 basis points at its September 15-16 meeting and deliver another quarter-point increase in December.
The revised outlook reflects concern that the disinflation process has been slower and less convincing than policymakers require. Oil prices above $100 a barrel, resilient demand and strong investment linked to artificial intelligence are adding to inflation risks.
The expected U.S. increase would be the first rate hike under Fed Chair Kevin Warsh, who has so far avoided offering detailed guidance on the likely path of monetary policy.
Financial markets have nevertheless moved strongly towards pricing further tightening. Higher energy prices have increased concern that inflation could remain above the central bank's target for longer, limiting the scope for an early easing cycle.
Morgan Stanley has also revised its view of European monetary policy. The bank now expects the ECB to raise its deposit rate by another 25 basis points in December to 2.75%, reversing its earlier expectation that the European tightening cycle had ended.
The change reflects stronger-than-expected euro-zone resilience and renewed energy-price pressures.
The more hawkish outlook has important implications for financial markets. Higher interest rates increase government and corporate borrowing costs, while higher bond yields can reduce the relative attractiveness of equities and other risk assets.
For businesses, the prospect of prolonged restrictive monetary policy could influence investment decisions, expansion plans and hiring. Economies with high levels of debt may also face greater pressure as financing costs remain elevated.
The changing outlook highlights how geopolitical developments can complicate monetary policy. Higher oil prices caused by supply disruptions can simultaneously weaken economic growth and increase inflation, leaving central banks with fewer attractive policy options.
For investors, the key issue is whether the recent rise in energy prices produces lasting second-round inflation effects.
Morgan Stanley's revised forecasts suggest markets may need to prepare for a longer period of restrictive monetary policy, particularly if energy costs and domestic demand remain strong.
