Markets are now betting on a 90% chance of a rate hike at Wednesday's Fed policy meeting following fresh inflation data that exceeded expectations. The Consumer Price Index rose 0.3% month over month in August, compared with expectations for 0.2%, while the year-over-year rate remained in line with expectations for 2.4% and down a tenth of a percentage point from July. On a headline basis, CPI rose 3.4% in August, in line with expectations, but the upside surprise to core CPI has significantly increased the likelihood of a Federal Reserve rate increase next week. As Capital Economics chief economist Stephen Brown noted, 'The upside surprise to core CPI in August means the Fed looks set to hike next week.' Recent economic data, including last week's strong jobs numbers and comments from Fed officials, have moved the needle in favour of a more hawkish policy outlook. The Fed has held rates steady between 3.5% and 3.75% for five meetings in a row and last made a change - a rate cut - in December.
The European Central Bank raised its key interest rate by 0.25 percentage points to 2.50% at its Thursday meeting, marking the second rate hike in 2026 after raising rates in June and keeping them unchanged in July. The ECB's Governing Council said the outlook remains 'highly uncertain,' due to a 'broad range of outcomes' for how the energy shock could affect growth and inflation. Starting from September 16, the three ECB key interest rates will be: deposit rate at 2.50% (up from 2.25%), main refinancing rate at 2.65% (up from 2.40%), and marginal lending facility at 2.90% (up from 2.65%). The ECB's chief economist Philip Lane has pointed to 2.5% as the upper bound of the ECB's neutral rate estimate, so any tightening beyond this month would tip policy into restrictive territory. ECB staff have revised their economic forecasts, now seeing overall inflation averaging 3% in 2026 (stable from its June forecast) and projecting core inflation at 2.5% in 2026, 2.6% in 2027, and 2.3% in 2028.
Central banks worldwide are facing mounting pressure to raise interest rates as energy costs continue pushing up inflation across major economies. The European Central Bank raised rates by 0.25 percentage points to 2.5% this week, citing the Middle East conflict and warning that inflation was 'set to remain well above' its 2% target for some time. Meanwhile, the US Federal Reserve is expected to make a decision next week, with above-target inflation at 3.4% and President Trump's comments that oil prices won't decline until after November's elections fueling rate hike expectations. According to Deutsche Bank, a rate hike is 'the most likely policy outcome' for the Fed, while almost universally, a rate cut appears off the table. The Reserve Bank of New Zealand hiked rates for the second consecutive meeting to 2.75% earlier this month, as expected, but also hinted that more tightening would likely be measured as risks to the economic outlook grow. The Bank of England is expected to leave rates at 3.75% when it meets later next week, despite inflation reaching 2.9% and energy bills rising to the highest level for three years heading into winter.
The US-Iran war and resulting higher global oil and gas prices are stoking inflation fears across economies. A barrel of Brent crude is now around $105, approaching levels last seen at the outbreak of the conflict. Shipments through the Strait of Hormuz waterway, one of the world's busiest oil and gas routes, have been restricted due to the war. In the UK, gas prices have risen above 200p per therm for the first time since the end of 2022, with millions of households set to see energy bills rise to the highest level for three years heading into winter. Despite these pressures, UK inflation remains at 2.9% and is expected to jump in coming months, though economists note there is 'no sign' of second-round effects of the price shock feeding through the economy. The rebound to oil at $100 per barrel also complicates the inflation picture for policymakers. Energy prices rise and Middle East tensions show little sign of easing, increasing the risk of further rate hikes by major central banks.
The strongest argument for structurally higher rates comes from AI investment, with enormous capital pouring into data centers, power infrastructure, and related sectors implying enormous demand for capital. According to ING, this should mean higher interest rates as more demand for capital increases its cost. Fed Chair Kevin Warsh's hawkish realignment has moved markets to pricing a two-thirds probability of a rate hike, though ING expects this to be a one-off recalibration similar to the 1997 rate hike. Central banks must balance the need to slow consumer spending and inflation through higher rates with the risk that higher rates can also encourage businesses to hold off on investing and hiring. RSM chief economist Joseph Brusuelas expects the Fed to hike at least two more times after next week over the next year to put inflation on a credible path back to 2%. However, President Trump continues to press for lower rates, posting on social media last week that 'The Fed Board, with its great new leader, must get smart - BE PATRIOTS for a change.'
