The Economist View
Bank of England: On hold, but closing in on a November hike
As expected, the Bank of England (BoE)’s Monetary Policy Committee (MPC) voted to hold the Bank rate at 3.75%. As in July, the vote was 6-3 with Huw Pill, Megan Greene and Catherine Mann voting for a rate hike. Under the surface though a lot has changed since July and, unsurprisingly they are sounding much closer to a rate hike.
Since July energy prices have risen much more than the bank had expected, with current energy prices around the peak incorporated into the adverse scenario.
Since July energy prices have risen much more than the bank had expected, with current energy prices around the peak incorporated into the adverse scenario. Based on current prices, the BoE now expects inflation to rise above 4% at the start of 2027. It sees inflation risks more broadly as greater than they were in July. The Committee’s key swing voters, including Governor Andrew Bailey, also sound individually more ready to support a rate hike in coming meetings if energy prices remain elevated. For now, a November hike would likely be part of a risk management strategy. The Committee still does not see clear evidence of indirect or second-round effects from the rise in energy prices.
Energy prices a focus, risks titled more to the upside
The minutes highlight the significant moves in energy prices since July, and the bank expects “any normalisation of energy supply would be slow and gradual”. Based on energy prices as of September 14th, the BoE now expects inflation to increase to around 3.75% in Q4 before rising above 4% at the start of 2027. The Committee also sees upside risks from food prices following an “unusually severe El Nino event” and continued demand for AI goods. As a result, the statement noted that “risks to the inflation outlook are tilted to the upside, and more so than at the time of the July Monetary Policy Report”.
The Committee still thinks that domestic conditions help offset inflation risks coming from energy prices, although did acknowledge stronger than expected growth and signs of stabilisation in labour market slack.
Still not seeing indirect or second round effects, but risks are increasing
The Committee continues to see “little sign so far of indirect effects” and second-round effects from elevated energy prices. The statement noted that indirect effects have actually been “less than expected at the start of the conflict” and food price inflation, in particular, has been weaker than expected. However, it remains attentive to the risk of second-round effects and “judged that the risk of material second-round effects has increased since July and was likely to increase further”. The Committee still thinks that domestic conditions help offset inflation risks coming from energy price rises, although did acknowledge stronger than expected growth and signs of stabilisation in labour market slack.
Financial conditions are still doing the work for them (but they may need to hike soon for this to be enough)
Since the start of the conflict, financial conditions have tightened, and the Committee continues to view that as helpful: “This would help lean against inflationary pressures.” Members put different weights though on whether that would endure if they continued to keep rates on hold. For now, most of them view the move in short-term market rates as “imparting a broadly sufficient degree of monetary policy restraint”.
The individual comments suggest some swing voters are close to voting for a rate rise
The three again voting for a rate hike (Pill, Greene and Mann) are continuing to argue for a risk management strategy. Swati Dhingra and Alan Taylor remain the most dovish-sounding on the Committee and put particular weight on the role of slack in the economy and the already restrictive level of policy and feel these allow them more time.
At the moment, we would therefore see Governor Bailey, Sarah Breeden, Clare Lombardelli and Dave Ramsden as the potential swing voters. Looking at their choice of language in the individual paragraphs, Bailey sounds one of the closest to a rate hike, saying that the upside risks to inflation have become more prominent given the geopolitics and “seeming loss of urgency to find solutions”. He said that with risks to energy and food prices more to the upside, second round effects could materialise more strongly and that “if the conflict in the Middle East persists for an extended period, as appears to be the case, and the risk of second-round effects emerging increases, it is likely that policy may have to tighten.” For Lombardelli, for example, “The outlook for energy prices is uncertain and could change in the coming weeks, but the case for raising Bank Rate is building the longer the conflict continues without lasting resolution.”
Path ahead – a November hike seems likely unless energy prices fall soon
The probability of a rate hike soon is rising. The key paragraph in this set of minutes, with words to that effect, was: “Taken together, the Committee judged that risks to the inflation outlook were tilted further to the upside compared with the time of the previous MPC meeting. And there was the possibility of a less stark trade-off between weak output and rising inflation in coming quarters. Given the lags with which second-round effects appeared, "it was not appropriate to wait too long for evidence of such effects before responding with policy."
By the November meeting the Committee will have the Autumn Budget and a new set of forecasts to digest. There isn’t anything the BoE can do to bring petrol prices down, but it remains worried that high inflation led by oil prices will feed through into a wider range of prices. Unless we get a significant fall in oil prices soon, we think the bank will hike in November. In the UK’s case, with its soft labour market backdrop, we are not convinced this would be the start of even a small series of hikes. Much will continue to depend on what happens in the Middle East.
The MPC have decided to slow the pace of QT and effectively map out the return to zero bonds held for monetary policy purchases.
Quantitative Tightening (QT) decision – slowing the pace of QT and with a multi-year strategy
The MPC have decided to slow the pace of QT and effectively map out the return to zero bonds held for monetary policy purchases. They have decided on a £46bn a year pace unwind of bond holdings which will imply active gilt sales of around £20bn a year (alongside maturing bonds). The final decision on a change in operational strategy has not yet been made it seems, but this would see the MPC decision get implemented through sales to the government and incorporated into the DMOs annual remit next year. The MPC did discuss the implications of this for monetary policy independence but regard the multi-year plan as maintaining that. On the plan they also outline “only two” circumstances where they would amend it: “First, if the MPC judged that potential movements in Bank Rate alone were insufficient to meet the inflation target. Or, second, if markets were judged by the Bank to be very distressed.”
US Federal Reserve: More hiking signalled
As expected by economists (at least by the time the meeting came around), the US Federal Reserve raised the Fed Funds target range by 25bp to 3.75%- 4.00% in order to (according to the sparse wording of the statement) “support a timelier return to the Committee’s 2% goal”. In the context of their dual mandate, Chair Kevin Warsh said that the labour market side of the remit is in good shape, meaning that the predominant focus is on inflation and that “inflation is too high and has been for too long”. He said that they must be confident that underlying inflation is moving towards their objective clearly and “at sufficient speed”. He said that today, the “FOMC decided that this standard has not been satisfied”. All this against a backdrop where, he repeated, he and the Committee would be hard pressed to see financial conditions as restrictive.
Having raised rates, this set of communications and recent movements in energy prices, it seems likely that the Fed will hike again this year unless oil prices drop significantly and soon (which can’t be ruled out).
The updated Federal Open Market Committee (FOMC) economic projections showed the median member pencilling in another hike this year (though again Warsh did not contribute to these). Having raised rates, this set of communications and recent movements in energy prices, it seems likely that the Fed will hike again this year unless oil prices drop significantly and soon (which can’t be ruled out).
Why hike?
Warsh gave a fuller account than he has at previous press conferences of some of the reasons for the decision. He talked about the decision as removing a “dose of accommodation” in the context of meeting their mandate. He made it sound as if this decision has been brewing for some time: “The decision we made today was a sober decision…one that we have been preparing for and thinking about in my hundred and ten or twenty days here.” And he also described what had changed since the July meeting, including 1) a good amount of data suggesting that the economy has strengthened, 2) nothing changing in his earlier judgement that inflation trends were not “passing the test” and 3) geopolitics.
Updated FOMC forecasts show another hike
The FOMC participant median forecast for this year is 4.1% (i.e. a target range of 4.00%-4.25%, implying one further hike). The median profile then has rates steady at that higher level in 2027 (though eight participants anticipate a further hike in 2027) before then cutting rates. The long-term Fed Funds rate was raised to 3.2% from 3.1%. All this falls well short of the market implied path though, where, ahead of the meeting, the market was priced for between three to four rate hikes by the middle of next year.
Other forecast changes are consistent with their move to raise rates – higher inflation, a lower unemployment rate and a higher growth forecast. The median inflation forecast this year nudged up a tenth to 3.4% with the median GDP growth forecast also revised up a tenth to 2.3%. Forecast personal consumption expenditures (PCE) inflation was unchanged for 2027 at 2.3% but again GDP growth was revised up a tenth to 2.4%. The unemployment rate forecast was revised down to 4.1% for all years, having previously been forecast at 4.3% in 2026 and 2027.
A number of things about today’s decision and press conference support the idea that a rate hike is more likely than not at one of the Fed’s forthcoming meetings, and that risks lean towards more than one hike while energy prices remain this high.
Support for a future hike: A number of things about today’s decision and press conference support the idea that a rate hike is more likely than not at one of the Fed’s forthcoming meetings, and that risks lean towards more than one hike while energy prices remain this high:
- In addition to the median FOMC rate forecast already including a further rate rise, on the median inflation projection, the PCE price index doesn’t return to target until 2029. Warsh in the press conference mentioned returning inflation to target at “sufficient speed”, although he offered no indication of what “sufficient speed” is. That said, we assume it would imply a faster return to target than the end of 2029.
- Although the FOMC statement now says little, the description of the economy still leans towards supporting a hike rather than a cut. As it did in July, the statement says economic activity is expanding at a “solid pace”, job gains “have kept pace with the workforce” and “inflation remains elevated.”
- As Warsh described it at least, they are still at the stage of reducing accommodation rather than adding to the amount of restrictiveness in policy setting.
- While not pre-committing to anything, Warsh made the rate rise sound like the start of something rather than the end of something. He said, “We are committed to a discipline not a decision. Today’s action starts to show we are serious about this and we will deliver on the price stability objective and as the statement said, we’ll do it on a timely basis. That’s our decision and when we continue our discussions over the next several weeks and months we’ll have more to say about it.”
Trends matter most, again consistent with further tightening
Warsh again stressed that he places limited weight on any single data release or variable. When asked about the market focus on the August CPI report for instance, he said that “markets have become accustomed to waiting somewhat breathlessly on a data point, that isn’t my view…I was not waiting breathlessly on what any particular data was”. Instead, he again mentioned the share of items in the inflation basket that are rising as a broad gauge of inflation pressure and emphasised that underlying trends in the data matter more than any single monthly observation. He argued that “this summer’s inflation readings do not tell me that underlying trends have meaningfully improved”. With trends taking longer to turn around than impressions from single data points, and a single Fed Funds rate hike itself unlikely to turn around any trend, this again supports the idea of further hiking.
The Fund Manager View
US Federal Reserve: central banks are rediscovering their willingness to fight inflation
Yesterday's Federal Reserve decision was supposed to be about interest rates…but it wasn’t really. The market had already priced that the Fed was hiking. Inflation remains uncomfortably high, growth remains resilient and higher energy prices have complicated an already difficult backdrop. The 25bp move was largely beside the point. The real question was whether the Federal Reserve could restore some credibility.
For the past few weeks we've watched an increasingly strange dynamic play out. Scott Bessent has been leaning against rising long-end yields while the bond market has continued to demand ever higher compensation for inflation risk, fiscal concerns and policy uncertainty. The irony is that higher yields were doing part of the Fed's work for it. Financial conditions were tightening naturally. Attempts to suppress long-end yields simply increased the burden on monetary policy. If inflation remains sticky and borrowing costs are artificially encouraged lower, central bankers ultimately have one response available to them…raise interest rates.
Markets may have been anticipating this increase in rates but perhaps not the more hawkish outlook from the committee. The updated path of interest rate projections suggested policymakers are becoming less comfortable with the idea that inflation will simply drift lower of its own accord. The message wasn't that another move is guaranteed, but more that policymakers remain willing to do more if necessary. That matters because markets have spent much of the last year assuming central banks would ultimately prioritize growth over inflation. The latest projections suggest policymakers are not prepared to put that option on the table for now.
The updated path of interest rate projections suggested policymakers are becoming less comfortable with the idea that inflation will simply drift lower of its own accord.
There was significant interest in how Kevin Warsh would spin the rate increase due to his apparent discomfort with the modern obsession around forward guidance. Markets have become conditioned to expect central bankers to telegraph every move before it happens. However, Warsh appears to have little interest in that game. In many respects he is trying to return monetary policy to something more straightforward. Stop obsessing about where rates might be in nine months and focus on what the central bank is trying to achieve. Yesterday's press conference felt consistent with that approach. His message was simple. Inflation remains above target. The economy remains resilient. The Fed's job is to restore price stability.
The political backdrop only made the meeting more fascinating. For months markets have questioned how independent the Federal Reserve would really be under a Trump administration that has repeatedly argued for lower rates. Investors have wondered whether political pressure would eventually influence monetary policy decisions. Yesterday the Fed tried to address that question by focusing on inflation. Whether there have been behind-the-scenes discussions between Trump and Warsh is ultimately unknowable and largely irrelevant. In fact, one could argue both sides emerged with a workable outcome. Trump can continue advocating for lower rates in the future. Warsh can demonstrate inflation-fighting credentials in the present. Either way, markets were left with the impression that the Fed remains prepared to make unpopular decisions if inflation demands it.
The market reaction was equally revealing. The initial move was exactly what you would expect from a hawkish surprise. Bonds sold off. Risk assets struggled. Investors rushed to reprice a more restrictive path for policy. However, that was fairly short lived.
A central bank that is willing to tighten policy in response to inflation is ultimately reducing future inflation risks. Nobody enjoys this, but a credible inflation-fighting regime should lead to lower inflation expectations over time. That appears to have been reflected in inflation markets, where investors began reassessing how much long-term inflation risk really needs to be priced into asset valuations. In effect, the Fed may have managed to regain some credibility while simultaneously reducing future inflation fears.
The market reaction is perhaps more important than the actual rate increase. The reaction signalled a growing sense that central banks are rediscovering their willingness to fight inflation. For much of the post-pandemic period markets have questioned whether policymakers still possessed the resolve to keep policy restrictive when confronted with slower growth, political criticism or market volatility. Increasingly, the answer appears to be yes.
The prevailing market narrative remains that inflation is structurally higher, fiscal deficits are permanently problematic and government bond investors deserve ever larger compensation for those risks. There is truth in all of that. But markets also have a habit of extrapolating today's concerns indefinitely into the future. What if central banks succeed? What if implied inflation expectations continue to fall? What if policymakers prove more committed to price stability than investors currently believe? In that world, today's bond yields begin to look increasingly attractive.
The prevailing market narrative remains that inflation is structurally higher, fiscal deficits are permanently problematic and government bond investors deserve ever larger compensation for those risks.
Our view remains that yields at the longer end of government bond markets look too high. Real yields look attractive too and markets appear to be pricing a world where inflation remains the dominant force for years to come. The Fed is signalling a world where inflation eventually loses. If policymakers are serious about that fight, investors may look back on current yield levels as a rather generous entry point rather than a warning sign.
For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.
