Two forces, one market

2026 was meant to be predictable, but it hasn’t been. The Middle East conflict triggered an energy shock that fed through to inflation and forced central banks to reassess their rate paths. At the same time, the AI boom via IPOs, record equity valuations and hyperscaler capex, has sustained risk appetite even as rates have moved higher. For cash investors, the key feature of the first half of 2026 has been a disconnect: risk assets have remained resilient, while rates markets have repriced and reset higher. The shift away from “cuts are coming” towards “higher for longer” is a positive backdrop for liquidity investors: today’s higher yields can be attractive in cash and short‑duration assets, and higher volatility can create more opportunities to add value.

UK: waiting for second‑round signals

The BoE’s June meeting underscored internal caution. The Monetary Policy Committee (MPC) voted 7–2 to keep the Bank Rate at 3.75%, with two members dissenting for a pre‑emptive 25bps hike. The domestic backdrop supports continued disinflation. Emerging labour‑market slack, subdued demand and tighter financial conditions should limit pricing power and dampen wage bargaining.

Energy remains the dominant risk. Prices have fallen, but they remain elevated and volatile. The BoE’s clear signal is to look through direct energy effects and respond only if they become embedded in wages and broader prices. Our view is an extended hold, with a single hike possible if oil prices re-accelerate or second round effects become more evident. Beyond that, a weakening economy and still‑restrictive rates point to cuts re‑entering the picture in 2027. UK politics adds uncertainty: leadership instability and any fiscal shift could sustain term premia in the gilt curve.

Euro area: resilient, but not immune

The Middle East shock upended our end‑2026 base case of a steady ECB hold. The US–Iran framework has since helped, with oil prices retracing and falling European gas prices unambiguously supportive for growth and inflation.

That said, we remain cautious about declaring victory. Geopolitics is still the swing factor, and the longer energy insecurity persists, the greater the risk of inflation pressure building and second‑round effects becoming more relevant for central banks. Europe is structurally more exposed to energy shocks, even if spillovers can be global through fuel prices, inflation expectations and tighter financial conditions. The ECB’s June projections tell the story: modest growth, inflation above target into 2027 and sticky core inflation.

Therefore, June’s hike to 2.25% was unanimous and deliberate. However, while President Lagarde’s tone was hawkish, she resisted pre-commitment. We expect one further 25bps hike in September; beyond that, the same scenario discipline that justified June’s move limits what comes next. Over‑tightening now raises the probability of reversal in 2027.

Policy expectations: markets may be too confident

Markets have increasingly embraced the view that policy will stay restrictive for longer, which is understandable given how cautious central banks remain on inflation. However, there is a risk in pushing meaningful easing well into 2027 as a base case: slowing growth can still force central banks to reduce the degree of restrictiveness, and that does not require a dramatic recession.

Implications for credit markets and cash investors

Credit spreads are tight, but we think they can stay there. Reduced tail risks, resilient earnings and AI‑driven sentiment argue against sustained widening, though summer volatility is likely. Front‑end euro yields are at multi‑year highs, offering genuine curve carry. We remain constructive on financials. Higher yields, more volatility and a steeper curve can support bank fundamentals, which is why financials remain a core part of our opportunity set and a preferred vehicle for credit beta. In a wider range of outcomes, active risk management matters more, not only in credit selection, but also in liquidity, duration and the agility to respond to headline‑driven repricing.

Conclusion

The ECB looks close to the end of its mini-tightening cycle; meanwhile the BoE remains patient as it assesses the risk of second-round effects. H2 2026 hinges on whether lower energy prices persist and whether inflation stays contained rather than broadening into wages and services. Geopolitics, via energy security and volatility, remains the key swing factor, and Europe is more exposed, even if spillovers are global. In this environment, we believe cash and short‑duration assets offer real value, and disciplined active management across credit, liquidity and duration has rarely mattered more.

Source of all data: Bloomberg, European Central Bank, Bank of England and J.P. Morgan Asset Management, as at 22 June 2026, unless otherwise stated.