At what price?

Inflation has moved back into the spotlight following its recent bounce in several key regions and wide-ranging trade tariffs from Donald Trump’s US government.

In this article, Matt Brennan, Head of Asset Allocation, looks at inflation trends and whether these could influence interest rate polices at major central banks.

When inflation soared a few years ago, the US Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) all raised interest rates to help bring prices down. For example, in the UK, the BoE’s Base Rate stepped up from 0% to 5.25% over a 14-month period through to September 2023. UK inflation topped out at 11.1% and then started to weaken. However, it took a while to be reined in and only ultimately reached its low of 1.7% in September 2024. The Fed and ECB saw similar paths for inflation and interest rates.

All three central banks judge inflation against a 2% target – at this level they want inflation to be sustainable over the medium-term, and with inflation seemingly in control and close to their targets, central banks started to cut interest rates during 2024. The ECB led the way in June 2024, while the BoE and Fed introduced the first of their rate reductions for the current cycle in July and September 2024, respectively. Lower inflation gave central bank policymakers room to manoeuvre in order to support their economies, encouraging consumer spending and business investment.

However, from the end of 2024, inflation started sneaking up again. In the UK, annual inflation reached 3% in January 2025 before it slowed slightly in February and March. Across the three regions, this bounce was due to common factors, such as food prices, as well as idiosyncratic issues, like private school fees in the UK.

Despite recent concerns surrounding the tariff changes, we still believe that inflation is unlikely to return to the elevated levels seen in recent years.

Although these rises were not particularly dramatic or large, there’s been some concern that a rise in inflationary pressure could halt progress in reducing rates or possibly even lead to higher interest rates again. This would have implications for regional and global growth prospects.

In its January World Economic Outlook, the International Monetary Fund (IMF) predicted that inflation would fall globally this year, helped by steady labour markets and a weakening of goods pricing. However, the IMF also flagged factors that may potentially disrupt the disinflation process, including:

• US migration policy – the IMF said that there was the potential for temporary disruption in the US labour market as its government tries to reduce inward migration.
• Geopolitical risk – any rise in tension in the Middle East and/or Ukraine could impact, for example, food or energy prices.
• Exchange rates – if the pace of interest rate policies start to diverge because of inflation, there could be an exacerbated impact on prices because of exchange rate changes.

The IMF had previously flagged that trade tariffs could also be an issue for prices. The new US government imposed a variety of trade tariffs early in 2025, including 25% tariffs on steel and aluminium imports, it then followed this up in April when it announced tariffs on almost all imports from across the globe, with the level adjusted by country. This led to market volatility and fears of inflation and worries about economic growth.

In the wake of these announcements, market participants adjusted their US rate cut expectations, with the consensus factoring in a greater number of interest rate reductions in 2025 in order to support growth as demand is likely to be hit. However, this will need to be balanced by the Fed against the potential for a short-term bout of inflation on the back of the tariffs. However, overall, it may lead to lower inflation globally as other countries see prices wane on the back of lower demand, particularly those that are net exporters to the US. The prices of crude oil futures slumped after the US tariff announcement in early April on worries about weaker global demand going forward.

Elsewhere, the BoE had recently pointed to the issues of geopolitical and economic uncertainty. Before the US tariff announcement, the BoE had been expecting inflation to peak at 3.75% in the third quarter of 2025, but said that it would keep a close eye on inflation risks.

There are other factors, too, that could prove inflationary, such as the recent debt ceiling agreement in Germany that will likely see the country up its defence and infrastructure spending.

Conversely, of course, there is also the potential for inflation to remain in benign territory, helped by, for example, extended ceasefires or even an end to fighting in the two main conflict zones. Additionally, trade deals could be struck, helping to lessen the impact of disruptive trade tariffs, which if that were to happen, could “even support investment and medium-term growth prospects”, according to the IMF.

Overall, despite recent concerns surrounding the tariff changes, we still believe that inflation is unlikely to return to the elevated levels seen in recent years. The driver from here will be expectations around the consumer price impact of tariffs, rather than the supply shortages that caused the spike in recent years. Given this and growth concerns, we believe we remain likely to see further interest rate cuts during the year, as the situation currently stands. This environment may see bonds returning to favour as a good diversifier in portfolios, given the healthy starting yields compared with just a few years ago.

¹ International Monetary Fund. World Economic Outlook Update, Global Growth: Divergent and Uncertain. Washington, DC. January 2025.