Interest rates: what should investors expect next?

With the Bank of England (BoE), the US Federal Reserve (Fed) and the European Central Bank all holding key interest rates last month, we look at what markets are watching for next. For investors, the key question is not simply when rates might move, but what the current environment means for portfolios and long-term investment decisions.

Rates may be on hold, but inflation concerns remain

The BoE's decision to leave rates unchanged at 3.75% for the fifth consecutive meeting came as little surprise. Inflation has moved closer to its 2% target, falling to 2.60% in the 12 months to June 2026 from 2.80% in the 12 months to May. Plus, markets didn’t expect policymakers to rush into rate rises. 

However, members of the Monetary Policy Committee (MPC) continue to warn that volatility in energy markets could reignite price pressures and delay the path back to sustainable stability. While six members voted in favour of interest rates being kept at 3.75%, three members voted to increase it to 4%. 

Rob Morgan, Chief Analyst and Spokesperson at Charles Stanley Direct, says the latest decision reflects the difficult position facing central bankers.

"It's no surprise the BoE has left rates unchanged for the fifth successive meeting. Inflation has been moving in the right direction, but renewed conflict in the Middle East has given policymakers reason to proceed with caution, making lower borrowing costs unlikely for the foreseeable future."

While households have welcomed signs that inflation is easing, the picture remains fragile. 

As Rob puts it: "Just as many families were hoping the cost-of-living squeeze was beginning to ease, a fresh inflation pinch point is approaching. Rate cuts are impossible to justify so long as inflation risks loom large on the horizon, while quelling it with a rate rise would increase borrowing costs and make things even harder for large parts of the economy.”

The BoE faces an awkward balancing act

The challenge for policymakers is determining how to respond to inflation risks without inflicting unnecessary damage on economic activity.

Oliver Faizallah, Head of Fixed Income Research, says: “Concerns over persistent inflation and central banks keeping rates higher-for-longer are unlikely to fade anytime soon. While most major economies are grappling with inflation driven largely by higher oil prices, their sensitivity to those prices and underlying economic resilience vary significantly. In weaker economies such as the UK and Europe, inflation is primarily being imported through higher energy costs, raising the risk of stagflation as weak growth collides with elevated prices.”

For now, the UK remains in wait-and-see territory. Although energy prices have remained volatile, the feared pass-through into wages and broader inflation has yet to materialise in a meaningful way.

Jeremy Batstone-Carr, European Strategist at Raymond James, says policymakers will be encouraged by recent data but remain vigilant. "The MPC will take heart from the continuing absence of pass-through from higher energy costs into the prices of other items or, importantly, into higher wage claims." However, he adds that a “wary policy hold” was always the most likely outcome for now.

As Rob Morgan puts it: “Unfortunately for households and businesses feeling the heat, the Bank faces an awkward balancing act, highlighted by the split in the MPC voting.”

Investors appear more optimistic than policymakers

While central bankers remain cautious, private investors appear to be expecting a more benign outcome.

According to Charles Stanley Direct research, the average DIY investor expects the BoE's base rate to be 2.86% in six months' time, implying a significantly lower level than today. Relatively few investors expect rates to remain above 3% by the end of 2026. Just 14% of DIY investors expect interest rates to remain in the 3.6%-4% zone in December 2026, while the same proportion expect interest rates to be between 3.1%-3.5% by that time. 

There is a risk that expectations have run ahead of reality.

Rob Morgan says: "Provided energy markets remain contained, the most likely outcome is a prolonged pause at the current 3.75%. Policymakers are seeing some encouraging signs that inflationary pressures will moderate once the current flare up passes. But until they are more confident that higher energy costs will not ignite wider price escalation or feed into wage demands, interest rate cuts are on ice."

This divergence between investor expectations and policymaker caution could create bouts of market volatility if economic conditions fail to evolve as expected.

The UK is not alone

The same theme is playing out across other economies, with concerns that higher oil prices stemming from the Iran conflict could keep inflation elevated and interest rates higher-for-longer. 

In the US, the Federal Reserve is grappling with an economy that has demonstrated resilience despite tighter financial conditions. Policymakers continue to signal concern about inflation pressures, even as growth remains comparatively strong.

Oliver Faizallah says: “The US continues to benefit from robust economic growth and a strong labour market, which are themselves contributing to inflationary pressures.”

Meanwhile Garry White, Chief Investment Commentator, says investors should not underestimate the Fed's determination to maintain price stability.

"Markets are likely to interpret the tone as hawkish. The emphasis on economic strength and persistent inflation pressures suggests that policymakers remain wary of easing financial conditions too quickly."

The message from central banks around the world is arguably becoming increasingly consistent. Whether in the UK, the US, the eurozone or Japan, policymakers remain wary of declaring victory over inflation too soon. Recent decisions from the European Central Bank and Bank of Japan to keep rates unchanged underscore a common theme: while inflation is generally moving in the right direction, concerns over energy prices, economic resilience and the risk of renewed price pressures mean central bankers are reluctant to signal a swift return to lower rates. For investors, that reinforces the prospect of a higher-for-longer interest rate environment.

What does higher-for-longer mean for investors?

For investors, the key lesson is that the precise timing of the next rate move may matter less than the broader environment.

After more than a decade in which ultra-low interest rates supported valuations across financial markets, investors are adjusting to a world where borrowing costs remain elevated and capital carries a meaningful price.

That has implications across asset classes. Could a higher-rate environment restore the appeal of cash and fixed income for some investors? How might businesses and sectors that have become accustomed to cheap borrowing adapt if financing costs remain elevated? And to what extent will equity valuations continue to be driven by shifting expectations around monetary policy? These are the questions investors are increasingly having to grapple with.

Rather than focusing solely on the next meetings, investors may be better served by considering how portfolios are positioned for a world in which rates settle at structurally higher levels than those experienced during much of the 2010s.

According to Oliver Faizallah, a divergence between economies “presents distinct challenges for central banks and creates a mixed backdrop for bond investors”. 

He explains: “Higher yields have restored income levels to fixed income markets that were largely absent for much of the past decade. However, evolving central bank rhetoric (or lack of, in the case of the new tight-lipped Fed Chair) and policy decisions, are likely to keep markets volatile as expectations shift.”

Meanwhile, from an asset allocation perspective, Abbas Owainati, Head of Portfolio Management & Asset Allocation, says: “Higher-for-longer calls for greater selectivity across asset classes. The energy shock’s second-order effects will take time to emerge and depend on the persistence of conflict in the Middle East, potentially forcing central banks to maintain a more hawkish stance or even raise rates further. That would challenge rate-sensitive assets and some of the more highly-valued equities, while improving the relative appeal of cash and high-quality fixed income.”

Looking beyond the next decision

Investors have spent much of the past two years debating when central banks will start cutting rates. Yet the bigger question may be where rates ultimately settle once inflation returns to target.

While the path from here remains uncertain, one thing is increasingly clear: policymakers are in no rush to loosen policy. For investors, that means preparing for a higher-for-longer environment, even if rate cuts eventually arrive.