Federal Reserve officials are wary of Russia’s invasion of Ukraine, though several have indicated in recent days that geopolitical tensions are unlikely to stop them from withdrawing support for the US economy as the job market booms and prices rise. rise quickly.
Stock indices are swooning and prices of key commodities – including oil and gas – have risen sharply and could continue to rise if Russia, a major producer, responds to US and European sanctions.
That makes the invasion a complicated risk for the Fed: On the one hand, its fallout is likely to drive further price inflation, which is already at its fastest pace in 40 years. On the other hand, it could weigh on growth if stock prices continue to fall and nervous consumers in Europe and the United States withdraw from spending.
The magnitude of the potential economic blow is far from certain, and for now central bank officials have indicated they will remain on track to raise interest rates from near zero in a series of hikes starting next month, a policy trajectory that will make borrowing money more expensive. and cool the economy.
Loretta Mester, president of the Federal Reserve Bank of Cleveland, said in a speech Thursday that she still expected it “will be appropriate to raise interest rates in March and follow with further hikes in the coming months.”
But she noted that the invasion could indicate how fast the Fed was moving over a longer time frame.
“The implications of the evolving situation in Ukraine for the medium-term economic outlook in the US will also be a consideration in determining the appropriate pace at which housing should be removed,” Ms Mester said.
Her comments were in line with those of many of her colleagues this week, including Thursday after the invasion: central bankers are monitoring the situation, but with inflation soaring and likely higher, they are not preparing to back up their plans. cancel economic aid withdrawal.
“I see the geopolitical situation, unless it deteriorates substantially, as part of the increased uncertainty we face in the United States and our US economy,” Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said Wednesday. at an event hosted by the Los Angeles World Affairs Council. “We’re going to have to navigate through that as we go along.”
But Ms Daly said she “sees nothing now” that would disrupt the Fed’s plan to raise rates.
Thomas Barkin, president of the Federal Reserve Bank of Richmond, said during a speech Thursday that “time will tell” whether the policy path needs to be adjusted. Raphael Bostic, president of the Federal Reserve Bank of Atlanta, said in a separate speech Thursday that it was not his basic expectation that the conflict in Ukraine would affect the timing of the central bank’s first rate hike.
Even if it isn’t enough to shake the Fed off course, some analysts are warning that the fallout from the conflict could be meaningful.
“Normally, geopolitical crises ultimately turn out to be a blur for financial markets and a buying opportunity for investors looking to see beyond the headlines,” Evercore ISI’s Krishna Guha wrote in a research note Thursday morning. “We are very wary of taking that line today.”
Mr Guha noted that the invasion could disrupt the post-Cold War world order and warned that the rise in energy prices and the fallout from sanctions would “affect the ability of central banks on both sides of the Atlantic to achieve a soft landing.” to deal with the pandemic will make it more difficult. rise in inflation.”
Economists have warned that a “soft landing” – in which central banks lead the economy on a sustainable path without triggering a recession – could be difficult to achieve when prices have risen and monetary policy is tightened in much of Europe and northern Europe. America may need to be adjusted substantially.
“The shock of the war adds to the enormous challenges facing central banks worldwide,” Isabel Schnabel, a board member at the European Central Bank, said at a Bank of England event on Thursday. She added that policymakers are “monitoring very closely” the situation in Ukraine.
Inflation is high in much of the world, and while it is somewhat less pronounced in Europe and ECB policymakers react more slowly than some of their global counterparts, recent highs there have prompted some officials to make policy changes. to implement.
In America, the Fed has sometimes responded to global problems by lowering borrowing costs, making money cheaper and easier to obtain, rather than raising interest rates and tightening credit conditions. But economists said it would likely be different this time.
Russia’s attack on Ukraine and the global economy
An increasing concern. Russia’s attack on Ukraine could cause staggering increases in energy and food prices and deter investors. The economic damage from supply disruptions and economic sanctions would be severe in some countries and industries and undetected in others.
“The current situation is different from previous periods when geopolitical events prompted the Fed to postpone or ease tightening as inflation risk has created a stronger and more urgent reason for the Fed to tighten today,” Goldman Sachs researchers wrote in an analysis note.
Furthermore, with wages rising and consumers expecting increasingly high inflation in the coming years, the fact that the conflict has the potential to further raise prices could be problematic for the central bank.
“Further increases in commodity prices could be more worrying than usual,” they wrote.
Some economists warned that the Russian invasion, in a sense, echoed the inflationary episode of the 1970s: then prices rose quickly, and a sharp rise in the price of oil pushed inflation up further and caused it to hang. The Arab oil embargo of 1973-74 and the 1979 Iranian revolution both contributed to an oil shortage.
Diane Swonk, chief economist at Grant Thornton, says: “There’s something eerie about the 1970s and the surge in energy prices linked to the Russian invasion of Ukraine. wrote on Twitter Thursday. “It couldn’t have happened at a worse time as it is pouring fuel over an already ignited fire of inflation.”
Economists have released varying estimates of the extent to which an oil price shock could amplify inflation in the coming months.
If the oil price rose to USD 120 a barrel at the end of February, while the oil price hovered around USD 95 last week, inflation, as measured by the consumer price index, could rise almost 9 percent in the coming months, instead of a expected peak of just under 8 percent, said Alan Detmeister, an economist at UBS who previously headed the Fed’s prices and wages division.
The Goldman researchers said that as a rule of thumb, an increase of $10 a barrel of oil would increase headline inflation in the United States by about one-fifth of a percentage point and decrease gross domestic product growth by just under 0.1 percentage point. .
“The growth blow could be slightly greater if geopolitical risk significantly tightens financial conditions and increases uncertainty for businesses,” they wrote.