Central bank updates: on hold as uncertainty heightens

Federal Reserve

The Federal Reserve kept the policy rate unchanged at 3.50–3.75%, as markets anticipated, but the main focus was on the rhetoric and the forward projections rather than decision itself. The only vote against the hold came from Stephen Miran, who argued for a cut, while members who were rumoured as potential dissenters, such as Christopher Waller and Michelle Bowman, ultimately stayed with the majority. The statement overall was broadly unchanged versus the previous meeting, however they did acknowledge rising uncertainty linked to developments in the Middle East, as expected, and also mentioned lingering concern about inflation pressures despite recent softer US activity data.

The market had a keen eye on the Dot Projections released alongside the decision. These continued to suggest that we should expect one rate cut this year, with minimal change to the overall median forecast of the dots, though perhaps at the margin highlighting a slightly slower pace of easing than signalled in December. Inflation forecasts for 2026 were nudged higher, with core PCE rising to 2.7% and headline moving toward 2.9%, largely due to elevated energy costs, while GDP expectations were marginally upgraded on productivity trends. At this stage, these inflation projections should be taken with a pinch of salt due to the ongoing conflict and it is likely that we now have a Fed even more data dependent. Prior to the conflict, inflation was perhaps at a level that didn’t quite justify the cuts priced by the market, despite some tentative growth concerns. The Iran conflict has now muddied these waters even further, which will likely put upward pressure on rate expectations.  

With geopolitical risks increasing the inflation outlook, investors reacted by pushing Treasury yields higher.

In the press conference, Jerome Powell repeated familiar caveats about uncertainty, but markets interpreted his messaging as firmer than expected. He noted that several policymakers had shifted toward fewer reductions in 2026–27, and he downplayed weaker payrolls by emphasising a stable unemployment rate. With geopolitical risks increasing the inflation outlook, investors reacted by pushing Treasury yields higher. The two-year yield rose by 15 basis points and the curve between the two- and ten-year point flattened, reflecting the lower likelihood of imminent rate cuts.

Equity markets also struggled against the backdrop of surging oil and gas prices, as well as a Fed that now seemed less likely to jump to their rescue if required. The overall impression is of a Fed unwilling to pre‑commit to easing, and a market adjusting to a world in which inflation uncertainty temporarily dominates the rates narrative. This is likely to prove uncomfortable for President Donald Trump and even when the new chair, Kevin Warsh, arrives, he will not be the commander and chief when it comes to rate moves. He will still need to bring the committee with him- a challenge that may be heightened by the current Middle East tensions.

Bank of England

The Bank of England decided to maintain interest rates at 3.75%, which was widely expected by the market. However, this outcome stands in stark contrast to just three weeks ago, when markets were almost fully priced for an interest rate cut at the March meeting, followed by two more 25bp cuts over the next 12 months. What a difference a few weeks and a significant oil shock can make!

Markets were keenly focused on the voting split, which ultimately proved to be the biggest surprise of the day. A 7–2 vote in favour of holding rates had been widely expected, with Dhingra and Taylor anticipated to vote for a cut. However, the vote was a unanimous 9-0, shocking the market and leading to a significant uplift in short dated gilts yields. The two year rate increased by 25 basis points and the curve between two and ten years flattened by 20 basis points.

What was particularly surprising though was a lack of any meaningful movement in the already-elevated inflation expectations. Given the committee’s more hawkish stance and a clear focus to contain inflation, one might have expected inflation expectations to ease but this was not overly evident.

Notably, even the most dovish of members advocated that rate hikes may be necessary.

Delving into the detail a bit more, it was clear that the committee were concerned about the impact of the Middle East conflict and not just the impact that this would have on energy prices, but on the second round effects of inflation. Members referenced the impacts of the 2022 Ukraine oil price shock but did caveat that the economy is in a different position today. Although they didn’t explicitly say it, they were perhaps alluding to the fact that they didn’t react quickly enough to the 2022 inflation spike and are poised to react quickly this time if needed. Notably, even the most dovish of members advocated that rate hikes may be necessary, albeit with the risk that this could ultimately lead to faster and deeper cuts should a growth shock materialise. While no official forecasts were published at this meeting, estimates indicated the MPC expects inflation to hit 3% to 3.5% over the next few quarters, well above their February expectations.

Governor Andrew Bailey sought to clarify some of the ambiguity from the minutes, emphasising that the key focus for policymakers would be evidence of second round inflation persistence rather than near term growth concerns. He also stressed the importance of returning to the 2% inflation target in the medium term. At the same time, he acknowledged the limitations of monetary policy in addressing this supply shock, particularly in the context of a real economy with limited pricing power. Thus, the committee appears to remain pragmatic and will be happier to maintain rates at current levels rather than risk a policy mistake by tightening too aggressively into a slowing growth environment. While six weeks is a long time in these markets until the next rate decision, it may prove difficult for the market to price in much more than the current estimate of three hikes to 4.5% by year end.

European Central Bank

Just over two weeks ago, the outlook for the ECB was clear: they were in a good place, with inflation forecast to be at their 2% target in the medium term. Rates were firmly in the neutral zone and incoming economic data was, largely, in good shape. Now, following the outbreak of war in the Middle East, the outlook is far more opaque. The oil price has increased by 50%, natural gas by close to 100% and there is little sign of a return to pre-conflict levels in the short term.

The question was not so much whether the ECB would tighten monetary policy on this occasion – no-one expected that – but, rather, what would the messaging be around future policy action?

For a central bank with a sole mandate of maintaining price stability over the medium term, this poses a dilemma; risk a repeat of 2022, when inflation spiralled out of control following Russia’s invasion of Ukraine, and policymakers reacted too slowly, or is it different this time? Markets were clear about what course of action the ECB may be forced to take, shifting from pricing further policy easing during 2026 as at the end of February, to fully pricing 50bps of hikes by the time the ECB met. The question was not so much whether the ECB would tighten monetary policy on this occasion – no-one expected that – but, rather, what would the messaging be around future policy action?

The decision to keep rates on hold was unanimous, with ECB President Christine Lagarde keen to stress that before doing so, the committee held in depth discussions. This was aided by very recently updated ECB staff forecasts (which incorporated data from the first 11 days of the conflict) along with briefings by experts, including a defence and military affairs professor, putting them in a position to be “calm, determined and laser focussed” on the information available to them when making their decision. However, Lagarde went on to stress that rather than being in a “good place” (as she had previously characterised their stance), given the developments over the past weeks, they now have a “good base” from which to make future decisions.

Uncertainty is heightened, risks to inflation are now tilted to the upside, risks to growth tilted to the downside, and the revised staff forecast reflect this. The path of future policy, for now, depends on the intensity, duration and propagation of the conflict – all of which will determine the economic impact and the actions required by the ECB as a result. Lagarde re-iterated their data dependant approach, explicitly outlining the key data indicators they will be watching, including commodity markets, supply bottlenecks, selling price expectations, demand indicators and wage trackers. All of these will shape their decisions going forward, but they stand ready to act, should it be required. Scenario analysis was also released to show the impact of alternative paths to their baseline predictions, largely centred upon when the oil price returns to pre-escalation levels.

When questioned on comparison to 2022, Lagarde pointed out several differences; inflation was already at 6% when Russia invaded Ukraine, monetary policy was firmly in accommodative territory (vs neutral now), labour markets are looser now and there is no longer the pent-up demand overhang from Covid lockdowns. They are now “well positioned”, supported by improved models, a better understanding of the pass-through mechanism of indirect and second round effects, and a greater determination to meet their price stability target.

It is the subsequent impact from further increases in the price of oil and gas on inflation and growth that may well force central banks to act, irrespective of what their models are telling them right now.

The messaging was one of preparedness, calmness, vigilance and unanimity. This reassured the market, to a degree, helping to reverse some of the previous weakness on the day. However, at this juncture, it is not central bank policy or rhetoric that is the key driver of sovereign bond markets. Instead, it is the subsequent impact from further increases in the price of oil and gas on inflation and growth that may well force central banks to act, irrespective of what their models are telling them right now.

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