18 Apr 2026
Rate path clouded by evolving Middle East conflict.
Key takeaways:
The US Federal Reserve left rates unchanged, as expected, maintaining the Fed funds target range at 3.5–3.75 per cent. In the press statement, the Federal Open Market Committee (FOMC) made clear that geopolitical risks add an increased layer of uncertainty to both sides of the mandate, but other than that, there was little change to the consensus-driven statement. Indeed, little change was the order of the day, with a small 20 basis point increase in core inflation expectations, which wasn’t mirrored on the interest rate side resulting in a modestly dovish tilt. However, the shift to a single dovish dissent, versus the two or three expected, added a slightly hawkish nuance. Taking it all together, the sense is of a committee constrained by uncertainty, waiting for events in the Middle East to unfold.
In the press conference, Chair Jerome Powell attempted to provide a measured and calm set of forward guidance emphasising the need not to overreact to current events, noting “it’s too soon to know how these will affect the data”, and stressing exceptionally high uncertainty. He instead placed emphasis on maintaining inflation credibility, particularly through the lens of inflation expectations. Chair Powell also made clear that the Committee is comfortable taking a wait-and-see approach as the impact of the conflict unfolds, while placing greater weight on the need for goods inflation to slow meaningfully over the year. He was explicit that any bias towards easing remains conditional on that progress materialising.
Looking ahead to the rates outlook for the rest of the year, this will unsurprisingly be dominated by developments in the Middle East. In our base case scenario of oil prices remaining elevated but rangebound at $90-$110/bbl, we would expect the Federal Reserve to remain on hold for longer, with the bar for near-term easing rising. That said, we do not think this environment, on its own, is sufficient to drive a renewed tightening cycle, as the growth drag should remain manageable and the shock is likely to have a one-time price effect, rather than being broadly inflationary.
By contrast, a move into an upside tail risk scenario with oil prices above $120/bbl (a significant fat tail risk that is currently rising in probability) would create a materially more difficult policy backdrop. Such a sustained oil move would reinforce a higher-for-longer stance, particularly if transport and broader goods prices begin to reaccelerate alongside rising fuel costs. However, we would also expect the medium-term policy path to become less linear, as a deeper energy shock would raise the risk of demand destruction and recession later in the year.
Taken together, if our base case scenario plays out, then we would still expect one to two cuts from the Fed this year. But we would note that events are shifting rapidly in the Middle East with signs of escalation appearing after Iranian energy infrastructure was hit on March 18, which, if this persists, almost certainly removes the chances of cuts this year.
In Asia, where economies are generally more vulnerable to potential supply shocks and price increases due to Iran conflict, the potential resurgence in food and energy prices reduces the probability of rate cuts in the region. An exception is the People’s Bank of China, which may still reduce rates by 10bps this year to support growth as China is more resilient to supply shocks and domestic demand recovery remains gradual. We expect most central banks in the region to keep rates unchanged in coming quarters while leveraging more fiscal measures to support growth.
ECB – from “a good place” to “well equipped”
The European Central Bank left rates unchanged and struck a calm and measured tone.
Christine Lagarde made clear that inflation risks were now to the upside and that the governing council would be focusing keenly on any evidence of second-round effects of the energy shock. For us this signals that the key going forward will be to closely monitor wage settlements, market inflation expectations, and company surveys to see if there are any movements in expected selling prices. Should these move upwards, the ECB will be in a clear position to hike.
In an extraordinary move, they shifted their forecast conditioning assumptions to take into account energy movements at the beginning of the US-Iran war, and as such upgraded their inflation forecasts while downgrading growth forecasts. These forecasts had inflation returning to 2 per cent in the medium term despite a near-term spike, but President Lagarde interestingly noted that these were conditional on market interest rate assumptions as of 11th March – when a little under two hikes were priced in for this year. Implicitly, this was thus not leaning against the idea of a near-term hike.
Of interest also were two scenarios published as part of the macroeconomic projections: one adverse and one severe scenario which outlined different paths for inflation depending on the scale and duration of disruption in the Middle East. Both of these scenarios had inflation firmly above baseline and are worth comparing to actual developments in the coming months to get a sense of how the ECB’s real time assessment is developing.
From our perspective we have now entered a situation of longer-run conflict with continued signs of escalation. Recent attacks on energy infrastructure bring scenarios much closer to the ECB's adverse/severe scenarios, with supply chain disruptions likely to continue going forward, placing upward pressure on energy prices. Incentives exist on both sides to de-escalate with the duration of the conflict key for longer-run expectations. Even with a resolution, permanent damage to production sites and sustained geopolitical risk premia are likely to keep commodity prices elevated.
The ECB has made clear that for now a hold is apt – but it is willing to act should evidence of second-round effects emerge, with data dependency being the order of the day in a world of clear uncertainty.
We believe that it is now more likely than not that the ECB hike, with June a likely date for the first move.
Bank of England – A surprise hawkish twist as memories of 2022 linger
The Bank of England struck a hawkish tone when holding rates today which surprised markets, with a clear message that the Bank is alert to increased risks of domestic inflationary pressure through second-round effects. This message, alongside the surprise unanimity of today’s vote, were taken to be a hawkish signal by markets, which are now pricing clear BoE hikes this year.
Crucially, the Bank dropped its guidance that “on the basis of current evidence, Bank Rate is likely to be reduced further” and instead stated that the Monetary Policy Committee (MPC) “stands ready to act”, removing the easing bias from the statement.
The inflation assumptions outlined in the minutes underscored the reasoning behind this hawkish pivot. Inflation is expected to be higher already in the near-term, with the Bank’s assumptions for March alone now 0.5 percentage points higher than projected in the February monetary policy report. It appears that 2022 is featuring strongly in the thinking, concerned that indirect effects may push up inflation further throughout the year.
Beneath the surface, the individual hawkish and dovish biases of MPC committee members could be seen. The hawks on the committee seemed to double down on their pre-existing concerns regarding inflation persistence, with the latest shock potentially amplifying it. On the dovish side, some members made clear that they believed a pause was prudent from a risk management perspective against a backdrop of uncertainty, but would have otherwise preferred a cut.
Divisions on the MPC suggest that going forward any attempts to hike will be hotly debated, even if all believed a hold was prudent at the current juncture. Andrew Bailey will remain the key swing vote going forward. Comments from Bailey pushed back against market pricing of hikes: “I would caution against reaching any strong conclusions about us raising interest rates”. This, for us, suggests that despite a hawkish tilt, the BoE’s statement today should be taken with the current uncertainty in mind, and hikes are not as certain as markets suggest.
It is clear that the starting point is far from 2022: rates are higher and the labour market is weaker. This should still provide the MPC with some caution going forward. While lessons from the inflation persistence of 2022 are at the forefront of the MPC’s thinking, key in their assessment will be the extent to which this start point impacts on price and wage setting behaviour against the backdrop of a weak labour market.
BOJ stays put with April hike still live, as oil risks tilt the balance hawkish
The Bank of Japan left its policy rate unchanged at 0.75 per cent in an 8-1 vote, in line with expectations. The statement carried a mildly hawkish tilt as it continued to describe the economy as growing moderately, while flagging caution around the Middle East and the risk of upward pressure on prices.
A new line in the statement stood out, pointing to the impact of the rise in crude oil prices on the outlook for underlying inflation. In theory, this could be interpreted as both an upside or downside risk to inflation. However, the statement made no explicit reference to downside growth risks from higher oil prices, which suggests the BOJ is more concerned about upside inflation risks. The statement also reiterated that if the outlook in the January 2026 Outlook Report is realised, the BOJ will continue normalising policy, which supports our view of leaning towards a hike in April.
Governor Ueda’s press conference was balanced as expected and he continued to highlight risks on both sides from the tensions in the Middle East. However, he remarked that board members were more concerned about upside risks to underlying inflation from higher oil prices than downside risks to growth. Broadly, the signal appears to be that, notwithstanding a major shift in expectations from the conflict in Iran, the BOJ is likely to proceed with a hike in April. That said, data-dependence remains key and the non-linearity of the oil price shock means the BOJ is likely to stay cautious. This was reflected in its emphasis on risks tied to the conflict, including oil prices, global growth and financial market conditions.
Beyond geopolitical developments, several domestic releases and events will shape the case for the next hike: the Shunto wage negotiation results in late March; the Tankan survey on 1 April; and the regional branch managers’ meeting on 6 April. If wage growth and underlying inflation continue to show strong momentum, the risk of the BOJ falling behind the curve could re-emerge. In addition, the impact on financial market conditions through changes in USD/JPY and JGB yields will also matter. Overall, the Bank is maintaining a cautious stance and remains reluctant to communicate a clearer long-term policy path. For 2026, we continue to expect further rate hikes at a semi-annual pace.
Elsewhere in Asia, economies remain more exposed to supply shocks and price pressures stemming from the Iran conflict. Governments across the region have already begun rolling out fiscal measures to cushion the hit. A renewed rise in food and energy prices also lowers the odds of rate cuts across the region.
China remains the main exception. We still think the People’s Bank of China could ease by 10 basis points this year to support growth, as China is relatively more resilient to supply shocks and the domestic demand recovery remains gradual. For most of the region, we expect central banks to keep policy rates unchanged in the coming quarters while relying more heavily on fiscal support.
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