By Daniela Hathorn, senior market analyst at Capital.com
It’s Fed day and markets will pay close attention to how Powell and his team are able to frame the narrative around the rising risks of renewed inflationary pressures. But the Fed is not the only meeting to watch out for this week, with the Bank of England and European Central Bank also likely to be closely watched on Thursday.
Central banks are entering this cycle from very different starting points, and that divergence is becoming more apparent against the backdrop of the current energy shock. The Federal Reserve finds itself in the most balanced position. Growth in the US has remained relatively resilient, but the labour market is beginning to soften at the margin while inflation, although moderating, remains above target. The rise in oil prices complicates the outlook, but for now the Fed retains flexibility. The likely message is one of patience: acknowledging upside risks to inflation while avoiding any firm commitment on the timing of rate cuts.
The European Central Bank also faces a challenging trade-off, albeit different. The eurozone is far more exposed to energy price shocks, and growth momentum is already weak. Higher oil and gas prices risk squeezing activity further while also delaying the disinflation process. However, the ECB has been more successful in lowering rates in the past 18 months, which gives them a bit more wiggle room to hike rates without pushing them into “too restrictive” territory, at least just yet. The ECB is likely to remain cautious, emphasising data dependence and avoiding strong forward guidance, but markets are already pricing one or two rate hikes this year.
The Bank of England arguably faces the most difficult backdrop. The UK economy is already showing minimal growth, with recent GDP data pointing to stagnation, while inflation remains stickier than in other major economies. The added pressure from higher energy costs increases the risk of a stagflationary environment. Unlike the Fed, the BoE has less room to manoeuvre, and unlike the ECB, it faces more persistent domestic inflation pressures. This suggests a more constrained policy path, with rate cuts likely delayed despite weak growth.
Across markets, investors remain in a holding pattern. The energy shock has introduced a clear inflation risk, but the ultimate impact depends heavily on how long the disruption persists. As a result, markets are highly sensitive to both central bank messaging and developments in the Middle East. For now, volatility is elevated but directional conviction is limited, with investors waiting for clearer signals on whether the current environment evolves into a prolonged inflation shock or remains a temporary disruption.
