Market overview: Policy inertia meets a geopolitical shock

The latest central bank messaging is less about conviction and more about constraint. The Fed’s decision to leave rates at 3.5% to 3.75% did not read as a classic hawkish pause. Instead, it exposed a committee still unsure whether policy is genuinely restrictive, yet equally reluctant to signal near-term easing. Markets took that as a sign that rate cuts may arrive later, not because the growth backdrop is reassuring, but because policymakers have limited room to respond cleanly while uncertainty remains so high.

Inflation is also becoming more difficult to read. Goods prices are starting to reassert themselves, tariff effects are feeding through only gradually, and higher oil is tightening financial conditions by stealth. At the same time, labour markets are softening, hiring is losing momentum and real incomes are under pressure. That combination leaves central banks facing an uncomfortable mix of sticky inflation and weaker demand.

For now, the dominant theme across North America and Europe is caution. Policymakers are waiting for clearer evidence, but the market is not being offered much visibility. With the next Fed meeting still weeks away, the near-term outlook is likely to remain hostage to developments in the Middle East, particularly the scale and duration of the US-Iran confrontation.

USD: Dollar supported by uncertainty, not optimism

The February PPI release reinforced the Fed’s dilemma. Final demand rose 0.7% month on month and 3.4% year on year, while core printed at 3.9% year on year. Those figures arrived alongside a sharp deterioration in the geopolitical backdrop, with Brent pushing above $109 as threats to Gulf energy infrastructure intensified. The result is a more challenging inflation picture just as the labour market continues to cool.

That backdrop remains broadly supportive for the dollar. The Fed’s updated projections still imply only a very gradual easing cycle, and futures remain hesitant to fully price a cut before the fourth quarter. More importantly, the dollar is currently trading as much on geopolitics as on macro data. As long as risks around Hormuz, shipping costs and energy supply remain elevated, pullbacks in the greenback are likely to prove limited.

There is also a broader policy lesson here. The Fed appears wary of repeating the 2021 mistake of underestimating inflation persistence during a supply shock. The difference this time is that demand conditions look much weaker. Job creation has slowed, real household disposable income has stalled and confidence has been dented by tariff concerns and job insecurity. That argues against a sustained second-round inflation surge and makes an outright return to rate hikes unlikely, even if Chair Powell acknowledged that the possibility was discussed.

Our base case remains for two 25 basis point Fed cuts in 2026, in September and December. That broadly matches the Fed’s own direction of travel, though we still see scope for easing to begin slightly earlier than the market currently expects.

GBP: BoE faces a tougher inflation trade-off

The Bank of England meets in a very different setting from the one it faced only a month ago. Before the latest rise in Middle East tensions, the story was relatively straightforward. The labour market was cooling, inflation looked set to return to target by April, and the Monetary Policy Committee’s narrow hold had left markets focused mainly on the timing of the first cut.

That view has now been challenged. The UK remains one of the most energy-sensitive economies in the G7, and the jump in oil and gas prices has forced investors to rethink the inflation outlook. What had looked like a clean disinflation story now risks becoming a more prolonged overshoot, with CPI potentially staying above target into 2026 if the energy shock proves persistent.

The MPC is still likely to keep policy unchanged today. The shock is too fresh and the uncertainty too high for any immediate action. The real focus will be on the tone of the statement and the Bank’s assessment of whether this is a temporary spike that can be looked through, or the start of a more durable inflation problem. The answer is unlikely to be binary. Domestic demand is softening, private sector hiring is becoming more cautious and youth unemployment is rising, but imported inflation risk has clearly increased.

For sterling, that leaves a mixed picture. Higher UK yields have helped support the pound against parts of Europe, but the broader deterioration in the UK’s terms of trade still argues for restraint. A firmer BoE tone could lift GBP in the short term, but lasting gains would probably require energy markets to settle. If the conflict drags on, the balance of risks still points to renewed sterling underperformance.

EUR: ECB may acknowledge the risk, but stay cautious

The euro has come back under pressure as markets focus on the risk to Gulf energy infrastructure and the implications for European growth and inflation. Oil has reacted more to Tehran’s warnings than to softer rhetoric from Washington, underlining where traders see the real leverage. With Iran holding significant influence over the Strait of Hormuz, energy-sensitive assets in Europe remain exposed.

That sensitivity has also shown up in rates markets, where government bond yields across the euro area have risen again, reversing some of the earlier normalisation. Even so, the pass-through into foreign exchange has become less reliable, with rate differentials carrying less explanatory power since the conflict intensified.

We expect today’s ECB meeting to produce only a limited market reaction. The Governing Council will probably acknowledge that the conflict introduces upside risks to inflation, but it is unlikely to commit to a materially more hawkish stance. Updated staff projections may not yet fully capture the latest energy shock, which should keep the message deliberately cautious.

There is a case for near-term downside risk in the euro if President Lagarde leans more heavily on growth concerns and pushes back against the market’s hawkish repricing. However, that repricing still looks fragile and underdeveloped, and FX markets have become less responsive to marginal changes in rate expectations. In practice, the euro may struggle to generate a decisive move even if some of that hawkish bias is unwound.

Looking ahead

• Fed pricing is likely to remain driven by geopolitical headlines as much as by macro data.

• Oil, shipping and insurance conditions around Hormuz remain central to the near-term FX outlook.

• For the BoE, unchanged policy looks likely, but guidance will matter far more than the decision itself.

• For the ECB, any acknowledgment of inflation risk is unlikely to translate into a firm policy signal just yet.

• Across G10 FX, the key question is whether the energy shock proves persistent enough to reshape central bank reaction functions rather than simply delay them.