Why monetary policy matters and what it means for your portfolio in 2025–26

Who sets rates, and what are they trying to achieve?

• United Kingdom: the Bank of England’s Monetary Policy Committee targets 2% CPI inflation. The target is set by the Government, the decisions are made independently by the MPC.
• United States: the Federal Reserve follows a dual mandate, maximum employment and stable prices, interpreted as 2% inflation over the longer run.
• Euro area: the European Central Bank targets 2% inflation on a symmetric basis. Deviations above or below are treated as equally undesirable.

In practice, all of them weigh the same families of data: inflation, the labour market, growth, credit conditions, financial stability and expectations.

• Inflation: headline and core readings, plus the mix under the bonnet. Services vs goods, shelter, healthcare, energy. In the euro area, July’s flash HICP sat at 2.0%. In the UK, CPI was 3.6% in June. In the US, CPI rose 2.7% year on year in July.
• Jobs and wages: unemployment, vacancies, participation, average earnings and unit labour costs. The Fed is openly balancing softer job creation against still-sticky inflation going into its autumn meetings.
• Growth and surveys: GDP trends, PMIs, retail sales and investment intentions.
• Financial conditions: bond yields, credit spreads, equity levels, mortgage costs, exchange rates and how they feed back into the real economy.

A quick snapshot of policy today


Numbers are as at 15 August 2025.

How rates move markets

• Bonds: policy rates anchor the front end of the yield curve. When cuts begin, high-quality duration usually benefits as yields fall, though the path is rarely straight. Credit spreads can tighten with improving growth visibility, but lower quality credit remains sensitive to default cycles.
• Equities: rates feed directly into the discount rate used in equity valuation. Lower rates support long-duration cashflows, usually a positive for quality growth. If cuts arrive because growth is rolling over, cyclicals can lag while defensives and profitable growth outperform. Sector and factor leadership often flips around policy turning points.
• Currencies: higher relative rates attract capital and typically support the currency. That affects sterling-based investors holding overseas assets, both positively and negatively. Singapore is the exception where the policy tool is the exchange rate itself.
• Property and private markets: financing costs and cap rates are the bridge between policy and valuations. Falling rates relieve pressure on refinancing and can stabilise transaction activity, although banks and credit funds may still keep lending standards tight.
• Cash: yields do not fall in a straight line with the first cut. Laddered deposits and short-dated T-bills can still pay attractive rates for a while, yet reinvestment risk rises as an easing cycle progresses.

What policymakers are watching into 2026

Three themes stand out.

1. Inflation progress is uneven. The euro area is near target, the US is hovering a little above, the UK is stickier given services and wages. UK CPI was 3.6% in June, euro area HICP was 2.0% in July and US CPI was 2.7% in July. Services components remain the swing factor everywhere.
2. Growth is soft, not collapsed. Central banks want to avoid overtightening into a slowdown. The Fed has flagged the trade-off openly, given weaker payroll gains since spring. Australia and Thailand have already cut to cushion growth.
3. Policy credibility matters. The ECB recently underlined that its 2% target is symmetric and that it will act forcefully if inflation drifts in either direction for too long. The Bank of England is easing, although senior officials have warned that services inflation and pay dynamics could slow the pace of cuts.

A grounded outlook for the next 12–18 months

• United Kingdom: gentle easing path if services inflation keeps trending down. Cuts are likely to be spaced, not rushed, while the Bank keeps an eye on wage growth and expectations. A relapse in inflation would slow or pause the cycle.
• United States: the path depends on whether inflation settles near 2% without a sharp labour downturn. A modest cutting cycle is plausible, starting later this year, provided the next few inflation prints cooperate and the jobs market continues to cool gradually.
• Euro area: with HICP at target and growth subdued, a patient hold into late 2025 is the base case, with any further adjustment dependent on services inflation and negotiated wages.

What we are doing in portfolios

Monetary policy is one input, not the whole story. Our approach remains consistent.

• Core bond exposure: maintain high-quality duration as a portfolio stabiliser. We are comfortable extending duration selectively where the compensation for risk is sensible, while keeping credit quality high.
• Equities: stay diversified across regions and styles. Do not chase a single narrative. Rebalancing remains essential if policy turns cause leadership to rotate.
• Cash and short-dated: continue to use them as liquidity reserves and dry powder, while recognising reinvestment risk as cuts progress.
• Currencies for expats: rate differentials can move sterling, the dollar and regional currencies meaningfully. We consider currency exposure when sizing overseas positions, and we use hedging selectively rather than mechanically.

The bottom line is simple. Policy is easing at the margin in several economies, yet central banks want proof that inflation is beaten before they declare victory. Markets will swing between soft-landing optimism and stickier-inflation worries. A disciplined, cost-effective core with measured tilts is still the best way to turn policy noise into long-term outcomes.

If you want your holdings sanity-checked against this backdrop, we can review your asset mix and the role of cash, bonds and currency risk within your plan.