Fidelity Comment | With the changing geopolitical landscape, how are major central banks responding?

In response to rising oil prices and ongoing geopolitical uncertainty, major central banks have noticed that risks are escalating. Fidelity's team of investment experts analyzes the latest monetary policy decisions from the US, UK, Europe, and Japan central banks. For more video insights and market analysis articles, please follow @Fidelity International.

The US Federal Reserve

The US Federal Reserve kept interest rates unchanged as expected, maintaining the federal funds rate target in the range of 3.5% to 3.75%. In the post-meeting statement,the Federal Open Market Committee explicitly stated that geopolitical risks brought additional uncertainty to its dual mandate of employment and inflation control. Other than that, the statement content aligned with market consensus and showed little change compared to previous statements.In fact, little change sums up the result of this meeting, where core inflation expectations were slightly raised by 20 basis points, but interest rate forecasts were not simultaneously adjusted higher, making the overall stance somewhat mild. However, it was originally predicted that two to three committee members would oppose standing pat and support a rate cut, but ultimately only one member proposed a rate cut, adding a slightly hawkish tone to this interest rate decision. Overall,in the face of an uncertain environment, the committee remained restrained and awaited developments in the Middle East situation.

During the press conference,Federal Reserve Chairman Jerome Powelltried to offer prudent and calm forward guidance,emphasizing that there is no need to overreact to current events, pointing out that 'it is still too early to determine how the Middle East conflict will affect the data,' while stressing the extremely high level of uncertainty at present.Instead, he emphasized the importance of maintaining inflation credibility, particularly from the perspective of inflation expectations.Powell also indicated that the committee is happy to adopt a wait-and-see approach, patiently observing the unfolding impact of the conflict, with increased attention on ensuring a clear slowdown in goods inflation during the year.He clearly stated that policy easing would only be considered if substantial progress is made in bringing down inflation.

Looking ahead to interest rate trends for the rest of the year, it comes as no surprise that they will largely be driven by developments in the Middle East. Regarding oil prices, our base-case scenario is that they will remain in the higher range of $90 to $110 per barrel. If this scenario plays out, we expect the Federal Reserve to stay on hold for a longer period, raising the threshold for rate cuts in the short term.Nevertheless, we believe that an increase in oil prices alone is not sufficient to trigger a new round of tightening cycles, as its drag on growth remains manageable, and the impact on prices caused by oil prices is likely to be a one-off effect rather than leading to broad-based inflationary pressures.

Conversely, if oil prices rise above $120 per barrel (a major tail risk whose likelihood is increasing), it would pose a significantly greater challenge to the policy environment.If oil prices remain persistently high, especially when transportation and other commodity prices accelerate again due to rising fuel costs, it would reinforce the policy stance of keeping rates 'higher for longer'.However, as deeper energy shocks increase the risk of demand destruction and economic recession later in the year, the medium-term policy path may also become more bumpy.

Overall,If our baseline scenario materializes, we expect the Federal Reserve to cut interest rates once or twice this year.However, we are also well aware that the situation in the Middle East is evolving rapidly. For example, after Iran's energy infrastructure was attacked on March 18th,there are signs of escalation. If this situation persists, the possibility of rate cuts this year will almost completely vanish.

European Central Bank

The European Central Bank kept interest rates unchanged, with a calm and cautious tone.President Lagarde clearly stated that inflation risks are now tilted upward,and the Governing Council will focus on whether there are signs of second-round effects from the energy shock. We believe this means the key going forward is to closely monitor wage trends, market inflation expectations, and business surveys to assess if expected prices change. If there are signs of an increase, the ECB will be ready to raise rates.

The ECB took a unique approach this time by incorporating energy trends into its forecast assumptions as early as when the US-Iran conflict began, thus raising its inflation forecasts while lowering growth projections.The European Central Bank’s forecasts show that although inflation will rise sharply in the short term, it will fall back to 2% in the medium term. Notably, Lagarde pointed out that these forecasts are based on market interest rate assumptions from March 11, when market pricing reflected nearly two rate hikes expected this year. This suggests the possibility of a short-term rate hike cannot be ruled out.

In addition,The macroeconomic forecast published by the European Central Bank includes two scenarios: an adverse scenario and a severe scenario., assessing the impact on inflation based on the severity and duration of disruptions caused by the situation in the Middle East.In both scenarios, the projected inflation is significantly higher than the baseline level., which can be compared with actual developments in the coming months to understand how the ECB’s immediate assessment evolves.

In our view,the current situation has already entered a prolonged conflict phase, with ongoing signs indicating the potential for escalation.Recent attacks on energy infrastructure have brought the situation closer to the ECB's adverse or severe scenarios, including likely ongoing supply chain disruptions, exerting upward pressure on energy prices. Both the US and Iran have motives for reconciliation, and the duration of the conflict will influence medium- to long-term expectations.Even if the conflict is resolved, permanent damage to production facilities and persistent geopolitical risk premiums could keep commodity prices elevated.。

The European Central Bank has indicated that it is currently appropriate to remain on hold, but it is ready to act if there are signs of second-round effects emerging.In the face of the current uncertain environment, the European Central Bank (ECB) remains committed to making decisions based on data.

We believe that at this stage, the likelihood of the ECB raising interest rates has increased,with the timing of the first rate hike likely to be in June.

The Bank of England

kept interest rates unchanged,but at the same time sent out a hawkish signal, which surprised the market. The Bank of England explicitly stated that it is closely monitoring whether second-round effects could lead to rising domestic inflation,and with the policy committee unanimously deciding to stand pat in an unexpected move, the market interpreted this as a shift towards a more hawkish stance,market pricing now reflects expectations that the Bank of England will raise interest rates this year.

The reason for the shift to a more hawkish stance lies in the inflation assumption. The inflation assumption in the meeting minutes shows that short-term inflation is expected to rise, with the March inflation forecast being 0.5 percentage points higher than in February. This reflectsThe Bank of England has learned from its 2022 experience and is concerned that indirect effects could cause inflation to rise further for the rest of the year.

Diverging opinions within the policy committee imply that even though all members unanimously agreed to keep rates unchanged this time, any future rate hikes will likely trigger intense debate.Governor Bailey remains the key swing vote. He stated: 'I would caution against jumping to the conclusion that we will raise rates.'We believe this indicates that despite the Bank of England's relatively hawkish stance,In a highly uncertain environment, the likelihood of a rate hike is not as certain as the market expects.

The current situation is clearly different from 2022,with interest rates now higher and the labor market relatively weak. Therefore, the policy committee will maintain a certain degree of caution.Even though the lessons from high inflation in 2022 were profound, the key assessment for the policy committee remains how the current situation, under a weak labor market, will affect prices and wages.

Bank of Japan

The Bank of Japan maintained the policy rate at 0.75%, in line with market expectations.The tone of the statement was slightly more assertive, while still describing economic growth as 'moderate'.At the same time, it reminded that attention should be paid to the situation in the Middle East and upward pressure on prices.

The statement added a new section pointing out the impact of rising oil prices on underlying inflation prospects. However, the statement did not mention the downside risks of higher oil prices on economic growth, indicating that the Bank of Japan is more concerned about rising inflation.The statement reiterated that if the forecast scenario from the January 2026 outlook report comes true, the Bank of Japan will continue its policy normalization, leading us to believe that an interest rate hike in April remains possible. Nevertheless, future decisions will depend on data, and fluctuations in oil prices could occasionally cause shocks, so the Bank of Japan is likely to remain cautious.

In addition to geopolitical developments, the future policy of the Bank of Japan also depends on certain domestic data and developments,including the results of the spring wage negotiations at the end of March, the Tankan survey on April 1, and the regional branch managers' meeting on April 6.If wage growth and underlying inflation remain strong, the Bank of Japan may once again face the risk of falling behind the curve.Furthermore, changes in the USD/JPY exchange rate and yields on Japanese government bonds are crucial to the financial environment. Overall, the Bank of Japan remains cautious but is unwilling to provide a clearer long-term policy path.We still expect that the Bank of Japan will raise interest rates at a pace of once every six months in 2026.

Asian Situation

InOther regions in Asia are more susceptible to supply shocks and price pressures triggered by the Iran conflict.Governments have introduced fiscal measures to cushion the impact.The renewed rise in food and energy prices has reduced the likelihood of interest rate cuts by central banks in the region.

However, China is a major exception.Given China’s greater ability to withstand supply shocks and the still moderate recovery in domestic demand, we expect the People's Bank of China to cut rates by about 10 basis points this year to support growth.We predict that most central banks in the region will keep interest rates unchanged in the coming quarters, relying more on fiscal measures to support economic growth.

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