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This week has been all about the central banks, with key meetings taking place in the US, Japan and UK. While policy decisions went as expected, the door has been left wide open for policy tightening if inflationary pressures continue to build.
As expected, the US Federal Reserve (Fed) raised interest rates by 25 basis points to 3.75-4%. The decision was unanimous and was the first rate hike since 2023. Fed Chair Kevin Warsh said in the press conference that “the plain fact is inflation is too high and has been for too long. This summer’s inflation readings do not tell me that underlying trends have meaningfully improved”. Warsh added that “I would be hard pressed to describe broad financial conditions as restrictive. This view was widely shared by the committee, so we removed a dose of accommodation”. Warsh presented an upbeat assessment of the US economy, saying “the American economy appears to be strengthening. New hiring, private sector earnings, business capital investment – each of these markers has improved in recent months and is pointing in a good direction”. Sixteen of the eighteen Fed officials surveyed projected at least one further rate hike by the end of the year, per the updated ‘dot plot’ of rate expectations. The projections also show the committee does not anticipate inflation reaching the Fed’s 2% target until 2029.
The Bank of England (BoE) kept interest rates on hold at 3.75% with the Monetary Policy Committee split 6-3, as it was at the previous meeting in July. Bank Governor Andrew Bailey said the global energy shock has so far had a limited effect on prices and wages in the UK, but commented “the longer this volatility persists, the bigger the impact it will have on inflation and the more likely it is we will need to raise bank rate”. The meeting minutes showed the Bank “stands ready to act” with “risks are tilted to the upside” and more so than in July. The BoE expects price pressures to build in the coming months, with inflation expected at 4% early in 2027. The Bank appeared to recognise that their Quantitative Tightening (QT) programme was imposing an unnecessary burden on gilts with the pausing of all QT auctions until next spring. Given the Bank will want to see interest rates remain above the prevailing level of inflation, rate hikes from the current level of 3.75% in the coming months appear highly likely in the absence of reduced energy price pressures.
The Bank of Japan (BoJ) raised interest rates by 25 basis points to a 31-year high of 1.25%, in a move that was widely expected. The policy board was split in a 7-2 vote. The two dissenters were recent appointments by Prime Minister Sanae Takaichi, who has previously criticised tighter monetary policy. The previous rate hike was in June; today’s move ends the previously indicated policy of rate hikes with intervals of around six months. The accelerated pace of tightening follows interventions to support the Yen and pressure from the US Treasury to increase the pace of rate hikes. The BoJ statement repeated previous concerns that underlying inflation could push higher than the Bank’s 2% target with upwards pressure from business-to-business transactions starting to “spill over into consumer prices”.
Brent Crude has traded all week above $100/barrel after Saudi Arabia closed the East-West oil pipeline, a route that has been crucial in mitigating the impact of the closure of the Strait of Hormuz. The Saudi government announced late last Friday that flows through the pipeline had been halted following drone attacks on Thursday. The 1,200km pipeline has a capacity of around 7 million barrels/day. There were differing reports on the timeline back to full capacity, varying between a “few days” and “3-5 weeks”. Bloomberg reported that Saudi Aramco was seeking to ramp up shipping volumes through the Strait of Hormuz to offset the closure of the pipeline. Meanwhile, President Trump again suggested on social media that Iran “wants to make a deal very quickly and badly” but this was countered by the Secretary of Iran’s National Security Council, Mohsen Rezaee, who said there would be no talks with the US until Iran’s conditions were met.
By the numbers
US inflation was in line with expectations for August at 3.4% year-on-year. (YOY) Energy was the primary driver of the acceleration in monthly CPI, which climbed from 0.1% month-on-month in July to 0.4% month-on-month in August. Core inflation was above expectations at 0.3% month-on-month.
The pace of UK inflation increased in August, with CPI at 3.1%—YOY, in line with consensus and up from 2.9% in July. The BoEoE had forecast 2.8%. The main contributor to the higher CPI print was transport (motor fuels) as the average price of petrol jumped by 9.1p/litre month-on-month. Food inflation was unchanged at 1.3% year-on-year while services CPI was 3.4% year-on-year vs 3.5% expected. With inflation already at a five-month high, the risks remain to the upside given that the energy price cap is currently expected to increase by 25% in January 2027, following an increase of 13% in July. Estimates for inflation in January 2027 range between 3.7% and 4.7%.
China’s ‘data dump’ for August showed industrial production up 5.2% –YOY, ahead of expectations for 4.8% and up from 4.5% in July. The increase was driven by external demand. The other data was less encouraging, with fixed asset investment down 7.2% for the first 8 months of the year compared with the same period in 2025, weaker than expected and on a deteriorating trend. Retail sales increased by 0.4% –YOY against expectations of 0.8% and slowing from 0.6% in July.
The investment lens
A rate hike or a hiking cycle? The moves from the ECB, BoJ, and Fed in the past week, and the likely rate hike from the BoE in the not too distant future highlight the shifting mood among the central banks on inflationary pressures and while the follow through from higher commodity prices into inflation has yet to fully show up in broader inflation data, it has become very clear that patience has run out.
For the US, the CPI data last week was the final piece in the jigsaw to firming up expectations for a policy move. Given Kevin Warsh’s stated frustration with inflation above target for over five years, the lack of disinflationary momentum in the data was enough to tip the balance in favour of tightening policy. Indeed, given the language in the past few weeks, the credibility of the Fed was at risk had they chosen not to raise rates. Bonds may actually be calmer with monetary policy being tightened, indicating the Fed is willing to take on inflation and as such reducing the risks of inflation staying elevated for even longer. Of course, a rate hike puts the Fed on a collision course with President Trump, who continues to argue that the strength of the US economy justifies lower interest rates. But given markets saw the rate hike as a ‘done deal’ as soon as the CPI data was digested, anything other than a rate hike this week would have put the Fed’s credibility at stake and likely added to bond market volatility.
So, is this ‘one and done’ or the start of a new hiking cycle? History shows that rate hikes are rarely one-off events, but there is a chance that it could be different this time – which brings us back to the US-Iran conflict and concerns that it will endure beyond the US mid-term elections, leading to persistent inflation pressures and as a result further rate hikes. But a resolution of the US-Iran issues would certainly change the outlook and likely trajectory for commodity prices and interest rates. But with both sides increasingly entrenched, no negotiations taking place and the conflict broadening further, the potential for central banks to feel the need to raise rates further looks high.
