Inflation Makes Rates Interesting Again

For much of the past few years, the central-bank story has revolved around one question: when will rates come down?

That conversation is starting to change. Inflation is building again in Europe, and the global policy cycle may be shifting back toward more rate hikes than cuts.

Euro-area headline inflation accelerated to 3.3% in August, its highest annual rate since September 2022. Inflation has now stood at least one percentage point above the ECB’s 2% target in three of the past four months, strengthening the case for further tightening.

The ECB’s Inflation Problem Is Still There

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There was some relief in the underlying data, but headline inflation remains high enough to keep the ECB concerned. After raising rates in June, policymakers may need to tighten further if price pressures persist. The challenge is that much of the inflation comes from energy prices, supply constraints and other cost pressures, which higher interest rates cannot directly address. Further hikes could slow spending and investment without fully solving the inflation problem, leaving Europe exposed to a difficult mix of persistent inflation and weaker growth. If both continue, the risk of a stagflation-style environment could increase.

17 Hikes, Four Cuts

Europe may only be part of a wider shift. Bank of America expects global central banks to deliver another 17 rate hikes and just four cuts through year-end. That would mark a significant change after years in which expectations for eventual monetary easing dominated the policy conversation. Instead, persistent inflation could force traders to reconsider how quickly interest rates can fall and how high they may need to stay.

Higher for Longer Gets a Second Life

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The consequences extend well beyond central banks. Governments generally benefit from cheaper financing, particularly as debt and interest costs rise. Central banks, however, risk damaging their inflation-fighting credibility if they keep policy too loose while prices accelerate.

If inflation proves stubborn, bond yields could stay high and equity valuations could face additional pressure. More tightening would also increase the risk of weakening economies that are already struggling to generate stronger growth. Central banks spent years trying to bring inflation back under control without causing a major downturn. The next challenge may be even harder: raising rates again after economies have already absorbed years of expensive borrowing.

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