Skip to content


Central Banks Step Into Potential Policy Error Territory

Hawkish stances risk overtightening and causing recession

Could we be entering the zone of a global monetary policy mistake? Recent hawkish stances taken by some major developed market central banks make this a valid question. There is now a meaningful risk that these central banks could overtighten in their quest to quell inflation and help push the global economy into recession as well as induce a financial market recession. China’s central bank, on the other hand, may not be easing policy enough to support the economy.

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)1 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)

Although the Fed kept rates steady at its June policy meeting following 10 consecutive increases totaling 500 bp, the Summary of Economic Projections (SEP) showed that policymakers expect to raise rates twice more in 2023. Fed Chair Jerome Powell underscored the Fed’s seemingly muscular approach to taming inflation by declaring that rate cuts are unlikely for a couple of years. This may have been part of an effort to convince markets not to price in cuts this year, and it worked—futures contracts post‑Fed meeting showed rate decreases starting in early 2024. However, Powell’s comment about not expecting cuts until 2025 was at odds with the SEP’s projections, which showed 100 bp of easing in 2024.

The Fed indicated that it will take into account the cumulative effects of policy tightening when determining how much more to raise rates, signaling that it is likely to take more time between hikes. But will that prove adequate to forestall a recession? The stickiness of core U.S. inflation and the Fed’s focus on returning inflation to its 2% target could easily lead the Fed to move rates too high and be slow to cut when the economy enters recession.

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 rate2 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)

For China, there are concerns that its central bank may not be cutting rates aggressively enough to sustain economic growth. The PBOC lowered its policy rate on one-year medium-term lending facility loans by 10 bps earlier in June, its first cut since August 2022. While it followed with minor cuts on the one- and five-year loan prime rates, some may argue it would require more efforts for China to achieve the government’s 5% annual growth target 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 premium3—and whether developed market sovereigns have enough risk premium.




1 A basis point is 0.01 percentage points.

The highest point in a monetary policy tightening cycle.

3 Risk premium is the additional return expected for taking on additional risk.


Where securities are mentioned, the specific securities identified and described are for informational purposes only and do not represent recommendations.

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. Investment involves risks. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. 

Previous Article


Volatility Brings Opportunity in Fixed Income
Next Article


Asia Credit Markets: Capitalizing on Emerging Themes and Exciting Opportunities


Volatility Brings Opportunity in Fixed Income

Volatility Brings Opportunity in Fixed Income

Volatility Brings Opportunity in Fixed Income

Interest rate markets offer alpha opportunities, dollar at risk of depreciation.

By Arif Husain, Scott Solomon & Quentin Fitzsimmons

By Arif Husain, Scott Solomon & Quentin Fitzsimmons