- After Jackson Hole, Fed’s Warsh faces another big test.
- Investors are split whether the Fed will hike.
- But BoJ seems poised to raise rates by 25bps.
- BoE to stand pat, UK data to take centre stage.
Uncertainty High Ahead of Fed Decision
A crucial central bank week looms for markets as both the Federal Reserve and Bank of Japan are under pressure from all sides, with their credibility at stake. The Bank of England looks set to have an easier ride, at least for now, while inflation releases will be watched too as war continues to rage in the Middle East.
Heightening the anxiety ahead of the rate decisions is the reduced transparency at the Fed, now that forward guidance is a thing of the past. But there can be no doubt that Fed chief Kevin Warsh upped the hawkish rhetoric in his Jackson Hole speech, although he stopped short of explicitly signalling a rate hike at the upcoming meeting. Other Fed speakers at the symposium and ahead of the blackout period were more direct with their calls for tighter policy. But two key figures – Governor Christopher Waller and the New York Fed’s John Williams – were notably dovish.
Thus, whatever the outcome of Wednesday’s decision, the vote will almost certainly be split. Markets are also undecided, assigning a two-thirds probability for a 25-basis-point increase in the Fed funds rate.
This implies a strong market reaction whichever way the vote goes, with the US dollar gaining if the Fed hikes. However, a meaningful dollar recovery is only possible if the Fed signals further tightening down the road in its latest dot plot. A hawkish hold may also boost the dollar, but any decision to delay a hike could further undermine the Fed’s independence, potentially offsetting any gains.
President Trump is once again demanding that the Fed cut rates, so the US has “the lowest rate of any country in the world”. Warsh may want to avoid coming under Trump’s firing line, especially before the November midterms.
The Fed’s ‘Invisible’ Obstacles
The dilemma is a tough one, as inflation remains well above the Fed’s 2% target, but jobs growth has slowed and consumers may be turning more cautious. The August retail sales report, due Wednesday, will be watched to see if retail spending declined for a second month. Other data will include the Empire State manufacturing index on Tuesday, housing figures on Thursday, and industrial production on Friday.
At the heart of the inflation debate is the question of whether there is enough disinflation to counter the brewing price pressures from the Middle East energy shock and chip shortages.
When considering how long inflation has been running above 2% and that the economy is hardly about to tip into recession, the choice for Fed policymakers should be an easy one. More importantly, the war with Iran is looking increasingly likely to drag on for some time, making second-round effects on inflation unavoidable.
As things stand, the Fed is at serious risk of falling behind the curve. One worry for the Fed is not to push Treasury yields even higher than they already are, amid the growing debt burden on the American economy. But long-term yields are more likely to decrease, as a rate hike would restore confidence in the Fed’s commitment to its inflation target.
Is BoJ at a Turning Point?
The Bank of Japan is another central bank in danger of falling behind the inflation curve. Although inflation in Japan has been mostly coming down during 2026, the trend may now be reversing, as the effect of previous government subsidies fades and high oil prices, as well as the yen’s earlier depreciation push up costs.
BoJ board members have become increasingly concerned in recent months about an inflation overshoot. Yet, Governor Kazuo Ueda has been reluctant to explicitly flag a faster pace of rate increases.
The real game changer for BoJ expectations has been the tougher stance by the Trump administration against further declines in the yen. Aside from the US Treasury Department’s willingness to intervene on behalf of the yen, the Takaichi government is under pressure from Treasury Secretary Scott Bessent to drop its objection to BoJ policy tightening.
An advisor to Prime Minister Takaichi recently hinted that the BoJ will switch from hiking every six months or so to every quarter, in a clear sign that the government is green lighting the BoJ to move at a more rapid pace.
Investors have priced in about a 75% probability of a 25-bps hike on Friday and a further 75 bps of increases after that until the end of 2027. But will this be enough to prevent the yen from sliding again? Ueda will need to strike a much more hawkish tone if he is to prevent the currency from being sold off on investor disappointment.
Just a few hours prior to the BoJ decision, CPI data for August will be released. After the slight uptick in Tokyo CPI in August, the nationwide numbers are also expected to inch higher.
BoE Not in a Hurry to Hike
As most major central banks have either raised rates or are edging closer to doing so, the Bank of England seems comfortable to remain on the sidelines, which is quite a shift from the alarm bells it sounded over inflation when oil prices first shot higher in March.
But as is the case within the FOMC, BoE committee members are also deeply divided. The Bank’s chief economist Huw Pill is one of the louder hawkish voices, while Governor Andrew Bailey has been leaning quite dovish lately. Only this week, Bailey hinted that a rate hike is not set in stone, while at Jackson Hole, he referred to second-round effects as being “subdued”.
In contrast, Pill, who voted for a hike at the July meeting, thinks that “a prompt increase” in rates is needed to “head-off” temporary inflation risks from becoming persistent.
Looking at the inflation data, the BoE can afford to wait a bit before deciding whether to hike. But like the Fed, its concerns about the economy are overblown while its focus on disinflation is equally dubious.
The UK’s headline inflation rate jumped to 2.9% y/y in July as the energy price cap went up 13% at the start of the third quarter. The energy regulator has already announced another increase for the fourth quarter, amounting to 4%. And with a ceasefire in the Middle East not being on the near-term horizon, further rises in UK energy prices are likely at the start of 2027.
This means that headline inflation can only head higher over the coming months. But the BoE will be paying more attention to core and services CPI. The August numbers are due on Wednesday and will likely add to some choppy trading for sterling ahead of Thursday’s rate decision.
Retail sales for August will follow on Friday, but Tuesday’s stats on the labour market will also be important. UK employment has been recovering mildly from a weak patch in 2025, but policymakers might be unhappy that the fall in wage growth appears to be bottoming out.
With the September meeting not being accompanied by a press conference or updated forecasts, investors will be seeking any clues about a November hike, while the data will also shape expectations.
Canadian CPI Eyed After BoC’s Hawkish Hold
Inflation will also be scrutinized in Canada where there are early signs of underlying price pressures picking up. Headline inflation has been hovering around 3.0% since April, mainly due to higher gasoline prices. But like its peers, the Bank of Canada has yet to be convinced of second-round effects.
Nevertheless, the BoC pointed to growing upside risks to inflation in its September policy statement when it kept rates unchanged, pushing up rate hike bets. Investors have currently fully priced in a 25-bps increase in December but a hotter-than-expected CPI report on Monday could bring forward those bets to October.
Moreover, if later in the week the Fed doesn’t live up to the hawkish expectations, the Canadian dollar could fly past the 1.37 mark against the greenback.
Elsewhere, the final estimates for Eurozone inflation in August are released on Wednesday, China publishes August industrial output and retail sales figures on Tuesday, and second quarter GDP data will be watched in New Zealand on Thursday.
