Central banks respond to new inflation threat

Like London buses, central bank meetings hunt in packs. This week we get interest rate updates from all of the big four - the Federal Reserve, Bank of Japan, ECB and Bank of England - and a supporting cast of others, too, from Canada to Australia, China to Switzerland.

Expectations of rate cuts have all but evaporated in the wake of the inflationary fall-out from the last two weeks’ Gulf conflict. No change is the expected response from rate setters this week. Further out, hikes are now seen as more likely than cuts.

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Return of stagflation?

The change in interest rate forecasts reflects the re-emergence of that 1970s bogeyman, stagflation. The unhealthy combination of inflation and stagnant growth would be an unwelcome consequence of continued disruption to oil flows through the Strait of Hormuz. It’s the worst possible outcome for central banks trying to balance their dual growth and inflation mandates.

How long the conflict lasts is the key unknown as we enter week three of the crisis. The weekend has seen President Trump calling on allies to send military support to the Gulf to help keep the oil flowing. So far, the response has been tepid at best. Most countries seem to prefer that ownership of the conflict should remain with the US and Israel.

With inflation’s retreat to central bank targets now stalled, markets are pricing in tighter monetary policy going forward. Both the ECB and Bank of England are now expected to raise rates before they start to cut again. The Fed is not expected to cut again until the middle of next year.

Economists are quick to point out that this is not 2022 all over again, though. The Russian invasion of Ukraine came against a backdrop of an already overheating economy, post-Covid. The situation today is very different - rising not falling unemployment, falling vacancies, stalling growth and tighter policy.

But oil remains key. The price of a barrel rose back above $100 over the weekend. A prolonged stay above that level would suit the oil companies, but no-one else.

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Reverse rotation

In an irony that won’t be lost on the rest of the world, the American economy, as a net energy exporter in recent years, is at least a partial beneficiary of a higher oil price. That goes some way to explaining the relative outperformance of the US stock market over the past couple of weeks.

Markets in Asia and Europe outpaced Wall Street last year and in the first two months of 2026 as investors looked for safer and cheaper havens outside the US and beyond big tech. That rotation went into reverse as conflict broke out in the Gulf. A flight to the perceived safe haven of the dollar has added to the woes of emerging markets in particular.

The rotation back to the US is a reminder that big asset allocation bets can be risky in an uncertain and unpredictable world. It argues for diversification, even when the direction of travel looks well set. Events come along to disrupt the clearest of investment plans.

Credit crunch 2.0?

The oil price is not the only source of investor nerves today. Rumbling in the background is another source of concern. This one is focused on a relatively obscure part of the financial markets - private credit - with some observers fretting about a return of the early stages of the 2008 global financial crisis.

Private credit - where companies which are shut out of traditional public markets or bank loans go for finance - has been a booming sector in recent years. But higher for longer interest rates and threats to some business models from AI disruption have soured sentiment, especially among wealthier retail investors who are worried about being locked into an illiquid asset class.

A sharp rise in redemptions from funds run by companies like Blackstone, Blue Owl and Apollo has put into reverse a five-year bonanza in which nearly $200bn has flowed into private debt funds. The share prices of the managers of these funds boomed and have more recently plunged again.

To some, it is eerily reminiscent of the early stages of the 2008 crisis.

This too shall pass

But for now, that is a problem for tomorrow. For the time being, the main concern is whether the Strait of Hormuz reopens to the lifeblood of the global economy. Investors are largely betting that there’s a quick resolution to the crisis.

Investors long ago stopped trying to second guess the intentions of the US President. But to the extent that they do try and read between the lines, they see a desire to find an ‘off-ramp’ - the declaration of a face-saving ‘victory’ that will allow the White House to shift back to domestic issues ahead of the upcoming mid-term elections.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.