Central banks could raise rates in 2026. This is the "pin" for the market bubble

The cycle of monetary policy easing by the world's leading central banks has come to an end. But regulators may have to raise rates already this year. This may become one of the key risks for the markets.

Last year, the leading central banks of developed countries cut interest rates in the most decisive way since the global financial crisis of 2008. Of the "Big Ten" countries with the most traded currencies on the world market, the central banks of Australia, Canada, New Zealand, Norway, Sweden, Switzerland and Switzerland eased interest rates in nine: in addition to the US Federal Reserve, the ECB and the Bank of England, which traditionally attract the most attention. In total, regulators in these countries cut rates 32 times last year by 850 basis points, according to LSEG. The number of cuts was the highest since 2008, and the scale of the cuts was the largest since 2009.

The only exception was the Bank of Japan, which after more than three decades of fighting deflation now has to contain rising inflationary pressures.

The sharp easing of the DKP followed its tightening in 2022-2023 as central banks grapple with high inflation caused by the effects of the coronavirus pandemic and rising energy prices following Russia's invasion of Ukraine.

It was also the fastest rate-cutting cycle in decades in the absence of a recession. In the case of the Fed, it was the first time this had happened since the mid-1980s, and the ECB had never conducted such aggressive easing of QE during economic growth, Reuters cited a December report by Deutsche Bank analysts.

Rapid rate cuts without a recession traditionally lead to a strong increase in economic activity, especially if accompanied by generous fiscal measures. For example, in the U.S., U.S. President Donald Trump managed to achieve tax cuts, Germany is increasing investments in defense and infrastructure, and other European countries are forced to rearm because of escalating relations with Russia. Japan's new Prime Minister Sanae Takaichi is also advocating fiscal support for the economy.

Toward the end of 2026, the situation may change dramatically. Central banks now have to find a balance in a very difficult situation, according to Deutsche Bank: it is difficult to expect a Fed rate hike in the near future, but given the international environment, it cannot be completely ruled out in 2026.

There are multidirectional forces at work in the U.S. economy itself, complicating the Fed's task. Inflation is falling, but it remains well above the Fed's 2% target. In November, annual inflation was 2.7%, while economists surveyed by The Wall Street Journal expected 3.1%, and it was 3% in September. Data for October was not published as government agencies were not working due to the shutdown.

At the same time, the economy grew rapidly in Q3 - by 4.3% in annualized terms. In Q4, it is expected to slow down due to the shutdown. However, overall, last year was characterized by rapid GDP growth with low employment growth: in average monthly terms, they were the lowest since 2003, unless you count the last two recessions, notes WSJ.

In 2025, "the Fed either didn't change rates or cut rates, there was never any talk of raising rates," says Luis Oganes, director of global macro analysis at JPMorgan(quoted by Reuters). But that is likely to change in 2026, especially in the second half of the year, when economic conditions could put the Fed in the position of having to choose whether to lower or raise rates, he believes.

Market participants, guided, among other things, by the statements of central bank leaders, expect about one more reduction this year from the U.S. Federal Reserve, the Bank of England and the Central Bank of Norway, according to the data collected by Reuters. Australia, New Zealand and Sweden may start a tightening cycle (and Japan may continue it).

The ECB has kept the rate at 2% since June 2025. Its chairman Christine Lagarde cited high uncertainty after the December meeting and refrained from forecasts.

Inflation in the eurozone, according to preliminary estimates of Eurostat, amounted to 2% in December (in line with the ECB's target) after 2.1% in November. In December, the ECB raised its forecast for eurozone GDP growth in 2026 to 1.2% from September's estimate of 1%.

The ECB may raise rates this year, and central banks in Australia and Canada will "move closer" to that decision, according to James Rossiter, director of global macro strategy at TD Securities.

December 2025 has already witnessed a shift in sentiment. Nine central banks have met, of which only the Fed and the Bank of England have cut rates, the others have not changed, and the Bank of Japan has raised rates. "In many of these countries, rates have already fallen a lot and the MPC is no longer tight," said Mike Riddell, fund manager at Fidelity International. And those central banks that started easing it earlier than others are now expected to raise rates rather than lower them, he added.

The risk of accelerating inflation is coming to the fore again, states Julius Bendikas, European director of economics and asset allocation at the management company Mercer(quoted by Reuters). He is not yet expecting a large-scale stock market correction because of this, but has started to reduce positions in debt markets.

Kevin Tozet, portfolio manager and member of Carmignac's investment committee, also urges caution: "Inflation can spook investors and cause some volatility in the markets."

In his view, with economic growth accelerating, "the risk of inflation is grossly underestimated," so Tozet began buying inflation-protected U.S. Treasuries (TIPS).

Along with inflation, the risk of rising interest rates is also growing. This, Tozet believes, will force investors to revise the P/E ratios of companies (capitalization to earnings ratio). The risk of such revision is especially high for companies related to AI development. Their capitalization has grown a lot. But many have begun to finance infrastructure investments with debt, the cost of which will rise if accelerating inflation leads to higher yields and central bank rates.

Investment in AI itself can be a strong inflationary factor because of the rate at which these projects "eat up" electricity and advanced chips. Such appetites lead to rapidly rising prices for both.

It is partly because of the huge investment in AI that US inflation will stay above the Fed's 2% target until the end of 2027, according to Andrew Sheets, strategist at Morgan Stanley.

"Our forecast is that total costs will increase, not decrease - because of rising chip and power costs," he told Reuters.

Wall Street analysts compiled by Goldman Sachs in December estimated that capital investment by leading tech companies in AI would total $527 billion this year. By Jan. 8, that consensus forecast had risen to $540 billion.

That said, analysts have so far underestimated the scale, Goldman Sachs points out: they predicted such investment would grow by about 20% in 2024 and 2025, while in reality each exceeded 50%. But despite the boom, investment in AI remains below the highs in previous technology cycles over the past 150 years - 0.8% of GDP, according to the latest data, compared with 1.5% in the past, the bank said in its report.

"It takes a pin toburst the bubble, and the tightening of the DCP is likely to play that role." It will undermine the appetite for speculative tech investment, raise the cost of financing AI projects, and hit the profits and share prices of tech companies, according to Trevor Gritham, director of asset allocation at Royal London Asset Management. He told Reuters he is holding on to Big Tech shares for now, but would not be surprised if inflation plays out globally again by the end of 2026.

Aviva Investors believes that if regulators stop cutting rates or even move to raise them in 2026 due to inflation being stoked by AI investment and government incentives in Europe and Japan, this could be a major risk to markets.

This article was AI-translated and verified by a human editor