European Central Bank (ECB)

The ECB provided what is probably the most obvious recent example of an extremely hawkish position from a major central bank. At its June meeting, the ECB raised rates by 25 basis points (bp) and President Christine Lagarde said to expect another hike in July. Most significantly, it surprised the markets by raising its 2025 inflation forecast—consensus expectations had been for a decrease in the inflation outlook, so the increase sent a strong hawkish signal.

As a result of this revised forecast for higher inflation, we think the ECB could even hike again at its next meeting in September. However, like most central banks, the ECB does not have a strong track record for accurately predicting inflation, so there’s a distinct possibility that inflation will be lower than forecast—resulting in overtightening of monetary policy.

Federal Reserve Bank (Fed)

Bank of England (BoE)

The BoE seemed to be on the right side of change when it became one of the first major developed market central banks to raise rates following the 2020 economic bounce back from the pandemic‑induced recession. However, it then adopted a “don’t worry, inflation will come down” stance through much of 2022. As a result, it fell behind the curve in inflation fighting, and headline UK consumer price inflation spiked to well over 10%.

Now public sector workers in the UK are demanding massive pay increases, raising fears that a wage‑price spiral may be setting in. In response, the BoE surprised markets with a larger‑than‑expected 50 bp hike to 5% at its June meeting, leading to expectations that its terminal rate for this cycle will be 6%. Mortgage rates could reach 8%, which would crush consumer spending in a country where fixed rate mortgages are rare. Pressured by this environment of still‑hot inflation, the BoE could easily raise rates to a level that would push the economy into recession.

People’s Bank of China (PBOC)

Of course, central bank policy errors can take different forms. Instead of raising rates too far, China may not be cutting them aggressively enough to sustain its economic growth. The PBOC lowered its policy rate on one‑year medium-term lending facility loans by a paltry 10 bp earlier in June, its first cut since August 2022. While it followed with minor cuts on the one‑ and five‑year loan prime rates, China’s economy is plainly faltering after a post‑zero‑COVID‑policy bump, and it could have difficulty achieving even the relatively modest 5% annual growth target that the government set for 2023.

But China is an anomaly in a world of many developed‑market central banks striving to contain inflation. By extending their hiking cycles amid sticky inflation, these central banks could be creating more economic pain down the line. In contrast, some emerging market central banks are successfully bringing inflation down after moving more quickly and meaningfully to raise rates. The central banks of countries such as Brazil are now considering rate cuts, leading us to question whether the local currency bonds of these nations are priced with an excessive risk premium—and whether developed market sovereigns have enough risk premium.