Global central banks are facing a fresh set of supply chain disruptions and stagflation risk. The conflict in the Middle East is posing a dilemma for central banks. In the U.S., tariff-related goods price pressures add a second supply-side impulse. Across Europe and the UK, the key question is whether higher energy prices trigger second-round effects. Central banks are opting for a wait-and-see approach for now, while keeping options open.

The U.S. Federal Reserve: Wait and see

The U.S. Federal Reserve (Fed) Federal Open Market Committee (FOMC) held the federal funds rate at 3.50%–3.75%, as expected. The statement saw the description on inflation upgraded from “somewhat elevated” to “elevated, in part reflecting the recent increase in global energy prices,” a direct acknowledgement of the oil shock. The Committee also maintained an easing bias in its outlook, but three voting members (Hammack, Kashkari, and Logan) opposed keeping the easing bias, even though they agreed with no change in the policy rate, arguing the inflation backdrop no longer warrants it. We argue that this disagreement is an important testimony of the Fed’s independence in policymaking based on economic data.

Fed Chair Jerome Powell’s press conference reinforced the balancing act. He reiterated his view that tariffs are likely to appear as a one-time price hike rather than an enduring inflation process, though the energy spike may warrant a more cautious “wait-and-see” stance given uncertainty over duration and pass-through into expectations.

Powell confirmed he will remain on the Board after his Chair term ends on May 15 for a period “to be determined,” citing the administration’s legal attacks against the Fed. He pledged to keep a low profile, support incoming Chair Kevin Warsh, and avoid any “shadow Chair” dynamic. More broadly, he argued that Fed independence is foundational to U.S. economic credibility and requires monetary policy decisions to be made free of political considerations.

We expect the Fed to stay on hold for the foreseeable future. Price pressures are clearly working against the dovish stance, but the bar to higher policy rates remains high. The Committee sees current policy as near neutral, allowing patience as the conflict and its impacts unfold. Even though the unemployment rate is relatively low, the ‘no hire, no fire’ job market means that wage growth is modest and does not pose an immediate threat to demand-side inflation. Still, the distribution of outcomes has widened. Market pricing has turned meaningfully more hawkish: the probability of a hike by April 2027 is now around 40%, a sharp contrast with expectations of no change until summer 2027 heading into the meeting.

Euro area and the UK: Finger on the trigger 

Both the Bank of England (BoE) and the European Central Bank (ECB) signaled policy restraint but not complacency, as the energy shock and its potential second-round effects dominate the outlook. The BoE left rates unchanged in an 8–1 vote, with a hawkish dissent from Pill. Governor Bailey described the stance as an “active hold,” arguing that tighter financial conditions should help curb inflation in the near term and buy time to evaluate incoming data. Consistent with that framing, the BoE retained a tightening bias, reiterating that it stands ready to act to keep inflation on track to return to 2% over the medium term.

The ECB also held policy rates unchanged for an eighth consecutive meeting, keeping the deposit rate at 2%. With no new staff projections, the debate in the meeting was around the possibility of a hike in June. President Lagarde mentioned that the March projection already had two hikes factored in, so a rate increase in the near term would be consistent with the central bank’s own view.

The key issue for both institutions is whether the energy shock remains temporary or becomes embedded via wages and pricing behavior. Relative to the U.S., inflation expectations over the next one year have risen substantially (Exhibit 1). In the UK, differences within the Monetary Policy Committee remain stark, with doves leaning toward the benign energy path and hawks emphasizing upside risks to persistence. Markets have correspondingly pared back BoE hiking expectations, with 60 basis points (bps) priced by year-end and the probability of a near-term hike falling sharply. 

In the euro area, despite markets pricing a more aggressive path (one hike by June and close to three by December), a plausible baseline remains for the ECB to stay on hold in a de-escalation scenario where energy flows normalize through May. If disruption persists, “insurance” hikes become more likely to anchor expectations and deter second-round effects—though the ECB could later unwind such tightening if the growth drag becomes decisive.

Japan: Looking both ways before crossing the road

The Bank of Japan (BoJ) held policy at 0.75%, but dissent widened to 6–3. Forecasts have more fully incorporated Middle East risks—lower growth and higher inflation—while guidance leaned toward opening the door for a June hike, but with less conviction on timing.

The BoJ still looks positioned for a hike in June or July absent sharp deterioration or market volatility, with the possibility of a second move in 2H26 (October/December) dependent on data and the lagged effects of prior tightening. USD/JPY exchange rate remains an important constraint and is increasingly influenced by global conditions and the Fed’s stance. The central bank will also need to be mindful of the risk to growth given Japan’s reliance on imported energy. It arguably faces a greater stagflation dilemma relative to the U.S. and Europe, and hence its central bank would need to approach policy with greater caution.

Investment implications

Just like central bankers, fixed income investors are at a crossroad. This also applies for broader portfolio construction and investment strategy. These four central banks are holding their breath, watching out for the development in the middle and the potentially complicated policy environment ahead. We discussed last week the central banks in emerging markets and Asia may not have the luxury to wait. In fact, Singapore and the Philippines have already tightened their monetary policy in April, and senior officials at the Bank of Korea are also hinting at the need for higher rates to cool down inflation.

In the near term, the risk of inflation for the global economy is more prominent given the surge in energy prices, and food production is facing the risk of disrupted fertilizer supplies and rising transportation costs. However, if the Strait of Hormuz remains closed for longer, the demand destruction could become more widespread and threaten the outlook for economic growth. This implies the long end of the government bond curves could see considerable whipsawing, with rates first rising on the back of inflation concerns, then falling when growth momentum comes under threat. Overall, a curve flattener could be a relatively cheaper way to hedge against this type of volatility, and hedge against inflation from supply shocks, instead of moving outright long duration.

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