Since the Global Financial Crisis of 2008, interest rates have moved broadly in tandem across developed economies. But now we expect diverging economic outlooks to drive interest rates in different directions.
What will this mean for investors and how will the spike in oil prices change the picture?
This article isn’t personal advice. Past performance isn’t a guide to the future. If you’re not sure what’s right for you, ask for financial advice.
From synchronicity…
The decade of sub-par economic growth after the financial crisis caused inflation to trend lower globally. Central banks responded by cutting interest rates – in some cases even into negative territory.
The COVID-19 crisis triggered a combination of supply disruptions and a big increase in government spending, which caused inflation to spike. A synchronous rise in global interest rates followed.
Then inflation peaked in 2022 and interest rates have gradually trended lower since.
…to divergence
The picture today is more complex.
Here in the UK, inflation remains stubbornly above the Bank of England’s 2% target. And the same is true in America.
By contrast, inflation in the euro area returned to target levels in 2025 and interest rates were cut to just above 2%. In Japan, after nearly three decades of near-zero inflation, persistent price rises are now putting upward pressure on the central bank to raise rates – which are still below 1%.
Beyond the developed world, China is pursuing an export-led growth strategy. This is putting downward pressure on the price of manufactured goods around the world. The notable rise in China’s car exports has both political and economic implications.
The Reserve Bank of Australia raised rates in January due to inflation concerns, joining Japan as the only other developed market central bank to reverse the downtrend in place since inflation peaked.
Looking forward
We expect the Bank of England and the US Federal Reserve to cut rates in 2026 as inflation trends back towards target levels. We see the European Central Bank remaining on hold, with the potential for rate rises next year. And we expect the Bank of Japan to raise rates, with the current interest rates well below the rate of inflation.
However, the current spike in oil prices may force us to revise these views. Indeed, the market has put on hold its expectations for the next rate cut by the Bank of England.
Higher oil prices affect the economy in two ways.
Most obviously, it drives up the price that consumers pay for petrol – pushing inflation higher. But it also acts as a tax on the economy, leaving consumers with less money to spend on other goods, which puts downward pressure on the prices of these goods. This tax on consumption can lead to recessions. We will be watching consumer confidence as a first signal of any slowdown.
Market implications
Bond yields are forward looking, embedding the expected moves in central bank rates. Therefore, a cut in interest rates does not guarantee lower bond yields. They also price in a term premium – the extra compensation that investors expect for holding a more volatile long-term investment instead of cash. The drivers of this term premium can be different to the drivers of short rates.
Foreign exchange markets also embed expectations – and so are driven by surprises. If the Bank of England cuts rates more than expected, we’d expect the pound to fall. If rates surprise us by rising, we’d expect the pound to rise too.
We would expect central banks to look through a temporary shock to inflation due to higher oil prices. A prolonged supply disruption would put central banks in a difficult situation though, as it increases the risks of both persistent inflation and a recession.
This “stagflation” is a bad outcome for investors. The only good news is that the global economy is less energy dependent than in the 1970s – the last time there was a period of significant stagflation and a challenging time for investors.
Profiting from correctly predicting policy surprises is hard. Instead, we advise investors to diversify their portfolios, making them more robust to policy shocks. Spreading exposures across different countries and currencies has the potential to reduce the volatility of returns.