This week in the markets: investors adapt to persistent inflation as central banks (with one notable exception) tighten together.

There were no surprises in the past week or so on the central bank front, with all but the Bank of England nudging rates higher. With little of note on the economic or corporate calendar, it’s a good time for investors to reflect on what the co-ordinated tightening cycle tells us about the investment outlook.

The most important of the hikes was probably the Fed’s. The 25-basis-point increase in rates was widely expected but significant, nonetheless. It was the firmest evidence to date that new Fed chair Kevin Warsh is his own man, prepared to resist pressure from the White House to keep rates lower than he and his rate-setting colleagues believe is necessary. It was important in that context that the decision was unanimous.

The projections for future rate hikes confirmed the committee’s shared view that inflation and resilient economic activity justified tighter policy. The dot plots that track expectations among the rate-setters point to another increase this year and no cuts next year. Inflation is not due to return to target until 2029.

Having spent five years already above the Fed’s 2% target that would mean a full eight years of higher inflation. This is not just a pandemic induced blip in inflation. It is arguably a whole new inflation environment. And that will continue to have an impact on the investment landscape for years to come.

A range of factors point to persistently higher price rises. Geopolitical fragmentation and the need to duplicate supply chains as globalisation fades, the need for greater energy security, persistent fiscal deficits as spending stays high and the ability to raise taxes is limited, not to mention the intense capital spending requirements of the AI boom all point to a more inflationary environment.

Kevin Warsh’s press conference after the decision was announced confirmed much of this. He said that the Fed had removed accommodation rather than made policy restrictive. That argues for further hikes to come. And he said that the Fed would require clearer evidence that inflation was heading back to target. Until that happens, investors would be wise to expect further rate rises.

There was some good news in the bond market. Long bond yields actually fell on the news. That suggests that the markets were impressed by the show of independence from the Fed.

What happens next is the unanswered question. It seems likely that last week’s hike was the first of several. Perhaps a three to four rate hiking cycle.

Whether that is necessary will depend in large part on whether the AI spending boom continues. The amounts being thrown at data centres, semiconductors, power grids and other infrastructure - and the bond issuance required to finance all of that - are big enough to move the needle on the economic cycle. If the spending continues higher rates will be both necessary and manageable. If spending were to fall off materially, however, the impact of higher rates on growth might quickly become apparent and force a reassessment of the policy risks.

The other important rate hike last week was in Japan. Although this, too, was expected, there remains some uncertainty about how far rates have to go in Japan and whether the Bank of Japan has the appetite to stay ahead of the US tightening cycle to both keep inflation in check and support the weak yen.

The messaging last week was ambiguous and markets have been left guessing about whether the next rise will be as soon as next month or not until December. The Bank of Japan governor Kazuo Ueda merely said that each policy decision would discuss tightening and that no timetable had been set.

This matters because despite Japanese interest rates rising to there highest for 31 years, they remain much lower than in the rest of the developed world at 1.25%. There is still a risk that inflation could overshoot the BoJ’s 2% target. The continuing war in Iran, which has raised the oil price above $100 a barrel, is a problem for Japan, a big importer of energy. So too is newish prime minister Sanae Takaichi’s planned fiscal stimulus for the Japanese economy.

With the European Central Bank raising rates the week before last, that left only the Bank of England leaving rates on hold this month. The Bank’s wait and see attitude is somewhat at odds with market expectations for four or even five quarter point rate hikes over the next year. It is quite likely that those hikes do not materialise, however, particularly if the government moves next month to squeeze the economy through higher taxes.

Earlier this year, markets were expecting a couple of rate hikes to have already happened in the UK by now and yet rates remain stuck at 3.75%. The Bank has clearly decided that it can wait for further evidence that energy price spikes - over which it has no control - are really feeding into higher wages and core inflation. If they do emerge then the Bank will quickly move to rejoin the global consensus on rates.

There is less on the radar this week to guide investor thinking about the outlook. But not nothing. In Japan, the focus will be on manufacturing and services purchasing managers indices on Thursday. Last month, the manufacturing PMI stood at 54.9, well in expansion territory for the eighth consecutive month. Services was also above the 50 watershed. Japanese companies are winning export orders and business sentiment is improving. That is leading to higher import costs as companies feel able to pass on costs. It all points to further tightening ahead.

Meanwhile, in Europe, despite a 40% rise in oil prices since July, the Eurozone economy is holding up better than expected. The ECB raised its growth forecast for 2026 by 0.1 points to 0.9% and by 0.2 points to 1.4% next year. As in Japan the PMIs due this week are expected to be well into expansion territory and the highest level for more than four years.

Here in the UK, growth is also reasonable but sentiment ahead of the Budget is subdued. And rising energy costs and high borrowing costs are clouding the outlook for new Chancellor John Healey as he prepares his first fiscal statement for October 28.

Worryingly, his fiscal headroom - the margin by which he is expected to be able to meet the government’s rule of balancing the current budget - is thought to have narrowed sharply. That raises the chances of further tax increases and speculation is bound to intensify over the next five weeks.

This is all being reflected in stock markets that remain close to their recent highs but which are running out of momentum. The AI trade has stalled, bond yields are rising and putting pressure on equity prices. Despite that, credit spreads remain tight, suggesting that investors are not too concerned about the corporate outlook, and earnings are still growing strongly.

A broadening market has helped offset the waning of the technology boom but only 29% of shares currently stand above their 50 day moving average and around half are above the 200 day average. It’s a nervous set-up for the traditionally difficult September and October period in the markets.

The S&P 500 has now trodden water since June as investors assess whether we might have now experienced peak earnings growth and worry about how long the Iran conflict will continue. When they look for what might be the catalyst for a further upleg in the market, they struggle to find one while seeing plenty on the horizon to worry about.

But equally anyone looking for parallels with previous market peaks such as the dot.com bubble 25 years ago are realising that in important ways it really is different this time. Unlike in 1999, earnings are booming so on a forward price-earnings ratio of 20 there is no evidence of a valuation bubble.

The threat to markets is therefore less about recession or slowing earnings and more about rising bond yields as investors struggle to swallow the high levels of issuance from both governments and companies alike.

What does it all mean for investors? It probably suggests still dancing while the music continues to play, but keeping an eye on the remaining chairs to avoid a nasty bump if things take a turn for the worse. Cautious positioning and diversification look sensible. And rotating towards more defensive positions in terms of growth vs value, the US vs the rest of the world, technology vs financials and industrials, big vs small.