By Raymond Backreedy, CIO of Sparrows Capital
Three central banks. Three meetings. One overriding question. Do you fight the fire in front of you, or do you wait to see how big it really gets?
As the Federal Reserve, the Bank of England and the European Central Bank each convene this week, they share a common and uncomfortably familiar adversary, an energy price shock driven by conflict in the Middle East, threatening to derail the carefully managed disinflation of the past eighteen months.
The parallels with 2022 are impossible to ignore. And yet, the correct response this time around may be precisely the opposite.
My expectation is that all three central banks will hold rates where they are this week and, crucially, that they are right to do so.
Holding pattern?
The Bank of England has already shown its hand. At its March meeting the MPC voted unanimously to maintain rates at 3.75%, acknowledging the conflict in the Middle East has caused a significant increase in global energy and other commodity prices, affecting both household and business costs.
This was a striking about-face from February, when several members who were previously ready to cut rates changed their stance, opting to hold while they gauge how long the energy price shock will last. The bank now expects CPI to be between 3% and 3.5% over the next couple of quarters, significantly above the 2% target it had previously expected to reach by April.
The ECB has similarly paused its easing cycle, deciding at its March meeting, to keep its deposit rate unchanged at 2.0%, acknowledging that the Middle East conflict would push up near-term inflation.
See also: UK unemployment drops to 4.9% but impact of Iran war looms
The ECB has raised its headline inflation forecast to an average of 2.6% in 2026 and revised down its growth forecast, creating the classic stagflationary bind that makes monetary policy so treacherous to navigate.
And in Washington, the Fed, still presided over by Jerome Powell, whose chairmanship formally expires on 15 May this year, is equally in a holding pattern. The Federal Reserve has extended its pause that began in 2026, with the median official forecasting just a single cut this year. Powell acknowledges the war in Iran has complicated the economic outlook to such a degree that even the summary of economic projections feels, in his own words, like one that could be skipped entirely.
The temptation for central banks facing an inflationary shock is to reach instinctively for the rate lever. It is the tool they know, the tool markets understand, and the tool whose deployment signals resolve. But resolve, in this instance, could be misdirected.
As the IMF has wisely cautioned, policymakers should resist the urge to respond immediately with rate rises when current inflation is supply-driven and potentially transitory. Raising the cost of borrowing cannot produce more oil, cannot unclog the Strait of Hormuz’s shipping lanes, and cannot reduce the geopolitical temperature by a single degree. What it can do is suppress domestic demand unnecessarily, deepen a growth slowdown already materialising, and most damagingly, lock in tighter financial conditions against a shock that may well be short-lived.
Lessons from the past
The evidence-based investor in me demands rigour here. We have lived through supply-side inflation before, and we have seen the asymmetric harm caused by overtightening. The lesson from 2022 to 2023 was not that central banks were too slow to act. It was that they were too slow to recognise that the underlying dynamics had already begun to resolve.
This time, with rates already meaningfully positive in real terms, the starting conditions are quite different.
See also: UK economic growth tops forecasts but impact of war yet to be seen
So what is the correct policy framework? The sensible approach should be for central banks to buy time, using the next quarter or two to assess whether energy price pressures are feeding into second-round wage and price expectations. If they do not, the case for further cuts remains intact.
Rate cuts are still expected in 2026, but timing is less certain, with forecasts suggesting one or two reductions and a potential year-end rate of 3.25% to 3.00% in the UK, depending on how inflation evolves. That is a sensible base case, and it is broadly consistent with our positioning of being cautiously optimistic, but with a clear eye on the tail risks.
Fiscal stimulus?
Governments, meanwhile, have a more immediate role to play. Fiscal policy can target the inflationary impulse directly in ways monetary policy simply cannot. Temporary reductions in energy duties, consumer subsidies and price support mechanisms were deployed during the 2022 energy shock; there is no reason to consider them off-limits now. The burden should not fall entirely on central banks to do the heavy lifting when the shock is exogenous and the right fiscal tools exist.
Finally, there is the question of Powell’s legacy and what comes next. Trump has nominated former Fed governor Kevin Warsh to succeed Powell. The transition, politically charged and procedurally uncertain, adds an additional layer of noise to an already complex picture. Powell will continue to preside over the FOMC until a confirmed successor is formally installed, which may stretch well beyond May. Markets should take note that the institutional continuity of the Fed matters as much as the individual at its head. Whoever chairs the FOMC next, they inherit a committee that is broadly consensus-driven, data-dependent and, for now, wisely cautious.
The verdict this week will likely be holding rates all round. The verdict for the remainder of 2026 will depend on whether the Middle East shock proves a squall or a storm. My reading of the evidence suggests the former is more probable, but in a world that has surprised us before, the only honest position is watchful patience.
