Central bank updates: on hold as uncertainty heightens

Federal Reserve: Changing of the guard

No one really expected the US Federal Reserve to move rates this week and the bank kept its target range at 3.5% – 3.75%. The main focus was on any debate within the committee and the scale of any dissent. The magnitude of this outcome caught markets slightly off guard. This was not a consensus “on hold” meeting as perhaps many expected, but felt more like a committee wrestling with its messaging and forward guidance, despite the policy rate itself remaining unchanged. One member pushed for an outright 25bps cut, while several others objected to continuing to signal an easing bias. The debate inside the Fed seemed to shift away from when to cut and more towards whether it still made sense to suggest that interest rate cuts are the natural next step.

Personnel changes became a key focus of the meeting, with Stephen Miran to step down when Kevin Warsh likely takes his place. It is hard to imagine Warsh leaning as dovish as Miran at the outset. Warsh will presumably be keen to establish his inflation targeting credibility early, and be conscious of the need to demonstrate independence from any political influence. Outgoing Fed chair Jerome Powell’s decision to remain on the board after stepping aside as chair reinforces that requirement. A chair being in the minority in voting for rate cuts, or struggling to command the respect of the committee would unlikely be well received by the market. It is unusual for an ex-chair to remain on as a governor and Powell cited the Department of Justice filings as the main reason. He has the opportunity to remain until 2028 (when his term as governor officially ends). In the meantime, this removes the opportunity for another potentially dovish political appointment, which helps anchor the Committee around a familiar, credibility‑first framework. Overall, this looks less like Powell trying to exert influence and more like an effort to protect continuity in a period of great uncertainty.

The market has now placed a non‑zero probability of a hike over the next year, where there had previously been none.”

Market reaction was relatively muted. Short‑dated breakevens edged slightly lower, consistent with the view that the Fed is comfortable sitting on its hands for longer if inflation risks persist. At the same time, front‑end rate pricing quietly adjusted. The market has now placed a non‑zero probability of a hike over the next year, where there had previously been none. The nuance was less about a return to tightening, but more about stripping out the assumption that the next move must automatically be lower.

If the median projections of interest rates continue to drift sideways, or show fewer cuts further out, then it raises the prospect that the Fed is more anchored around patience, as they continue to assess incoming data. The fear for the front end of markets and risk assets is that the easing bias is being worn away, even if it has not yet been formally removed, the latter always thought the Fed have their back and would ease interest rates at the first sign of economic trouble. However, this may now not be so obvious and higher short term borrowing costs could weigh on the economy. 

For now, the Fed remains on hold. This was a predictable pause but with unexpected internal tensions. The Committee seems less unified, the messaging more contested, and markets may need to adjust to a world of higher interest rates for longer than was previously assumed. How this will play out in the growth and inflation mix going forward will be an interesting watch.

Bank of England: firmly on hold

At this week’s Bank of England (BoE) meeting, the Monetary Policy Committee (MPC) voted 8–1 to maintain bank rate at 3.75%, a decision that was widely anticipated by economists and financial markets. Given there was little priced for a change in rates at this meeting, the vote split was seen as a key guide to the possible future path for rates. The question on many market participants minds was ‘just how ready might the MPC be to start hiking’? While the return of a dissenting vote inevitably drew some attention, the overall takeaway was marginally less hawkish relative to the market’s expectations for a 7-2 split, and there was little evidence that the MPC was in a rush to start hiking.

Compared with the March meeting, which surprised the market with a unanimous 9–0 hold, and a set of minutes that were collectively interpreted as being hawkish, April’s meeting was more balanced, with the committee using scenario analysis as a framework to guide future rate expectations. Overall, the majority continue to favour caution at this stage. Governor Andrew Bailey described the decision as an “active hold”, noting that the absence of cuts relative to a few months ago, already delivers additional restraint relative to earlier expectations. With policy deemed restrictive, the MPC emphasised the need to wait for clearer evidence on inflation persistence, and spot inflation spilling over into second round effects, before any hike in rates can be considered.

Global bond markets have been rocked by the Iran war, and the impact that the closing of the Strait of Hormuz has had on commodity prices and inflation expectations. The UK gilt market has moved rapidly, from pricing two additional cuts in bank rate throughout 2026 at the end of February, to a little over three hikes by the end of 2026 going into the April meeting. Given the BoE’s scenario analysis, and its forecasts for both growth and inflation, that seems overly optimistic at this stage. Governor Bailey spent a considerable amount of time in the post-meeting press conference emphasising that more time was required.

At this stage the gilt market is placing a greater weight to inflation, and the perceived need for the bank to hike rates to combat rising inflation expectations, than it is on the potential growth shock that might emerge as the war drags on.”

Furthermore, the UK economy is in a very different position to 2022 when Russia’s invasion of Ukraine sent commodity prices soaring. Growth remains weak and the labour market fragile. Additionally, the starting point for bank rate is significantly higher at 3.75%, and in restrictive territory, whilst the rapid move higher in gilt yields has also tightened financial conditions, particularly in the mortgage market. At this stage the gilt market is placing a greater weight to inflation, and the perceived need for the bank to hike rates to combat rising inflation expectations, than it is on the potential growth shock that might emerge as the war drags on.

At the end of February, yields on shorter maturity gilt yields had become relatively less attractive; on the balance of risk and reward, and already priced for base rates to come down to 3.25% by the end of 2026, our gilt strategies had reduced duration, and gone neutral the front end, preferring longer maturity bonds relative to shorter maturities; particularly given the relative steepness of the yield curve.

Since then, the markets’ expectation of the neutral rate has increased from 3.5% to around 4.5%, a rise of 100bps. Regardless of where base rates go in the short term, that is remarkably high for an economy that has anaemic growth, a fragile labour market, and where the magnitude of any second round affects from this supply side induced energy price shock is hard to quantify. When markets closed on Thursday night, seven-year gilt yields were hovering around 4.75%, a higher yield than at any point in the last five years when inflation was above 10% and base rates rose to 5.25%. Given the balance of risks, we think that shorter maturity gilts – particularly five to seven-year maturities – are attractive, and our gilt strategies are once again long this area of the curve.

European Central Bank: The benefits of starting from a good position

Over the past six weeks since the European Central Bank (ECB) last met, through clear and careful communication, the market fully expected the ECB to keep rates on hold at its April meeting, while simultaneously crystallising pricing around a rate hike for June. This was despite a further 10% increase in the price of oil, and little sign of an imminent end to the blockage of the Strait of Hormuz. The statement from the ECB governing council following its monetary policy meeting was little changed, other than highlighting the “intensified” upside risks to euro area inflation and downside risks to euro area growth. The ECB had clearly outlined its reaction function, process and precursors to policy action, stressing the key tenets of data dependence and assessments of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission.

The messaging was clear: the market should be prepared for a hike at the June ECB meeting, consistent with each of the ECB’s own scenario forecasts.”

In the accompanying press conference following the “on hold” decision, President Christine Lagarde was keen to stress that, as the bank was starting from a good position (as a result of previous policy action), it is able to wait until its June meeting, when it will have more data (including revised staff forecasts) with which to make a better informed decision as regards changes to policy rates. Notwithstanding this, the messaging was clear: the market should be prepared for a hike at the June ECB meeting, consistent with each of the ECB’s own scenario forecasts. The extent of this hiking cycle remains dependent on incoming data in an “ocean of uncertainty”, but the determination of the governing council to ensure they adhere to its mandate of maintaining inflation at 2% in the medium term was unwavering. Any second-round effects from the current energy price shock are likely to be a bit clearer in six weeks’ time, as may be the duration of the conflict in the Middle East and resulting supply disruption. This will all help the governing council take what it believes is the correct degree of policy action at that time.

As was perhaps to be expected, given the clear signalling over recent weeks, the market reaction was very muted. Short-end yields in Europe have been moving in line with gyrations in the price of oil, as has the degree of policy tightening expected over the remainder of 2026. The market is currently pricing just under three 25bps hikes from the ECB this (unchanged from before this meeting), one more than two of the three scenarios that the ECB outlined at their April meeting. Lagarde promised a refreshed set of scenarios in six weeks’ time, to accompany the revised forecast in the light of the new data available by that point. Whether three hikes turns out to be the correct forecast remains to be seen, but European policy rates are unlikely to remain where they are when the ECB next meets.

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