By Howard Schneider and Mark John
(Reuters) – The well-scripted turn by global central banks towards tighter, post-pandemic monetary policy has been thrown into doubt by Russia’s invasion of Ukraine, a geopolitical upheaval likely to be felt differently across the world’s major economic centers even as it poses some common risks to global growth.
The risks included a near immediate spike in the price of oil to above $100 dollars a barrel, and the longer-term imponderables of what the revival of European land war could do to confidence, investment, trade and the financial system.
To many analysts that has increased the likelihood that central banks, having positioned themselves for a head-on fight against inflation while expecting continued strong economic growth, may now see prices continue to surge while growth ebbs – a situation not easily resolved with standard central banking strategies.
“For the major advanced economy central banks the intensification of the war now leaves them in a distinctly worse position,” Oxford Economics analysts wrote. “The high starting point for inflation…will make it hard for central banks to ignore the near-term upward forces on inflation. But at the same time, they will be aware that the latest developments increase the risks of very low inflation in late 2023 or 2024 due to a weaker growth outlook.”
Apart from Russia, Oxford analysts noted, Europe would be hardest hit by these developments. They forecast average annual headline Consumer Price Index inflation in the eurozone will rise to 4.6% this year and then fall off sharply to a 1.3% rate in 2023. For global CPI, it lifted its forecast for this year to 6.1% from 5.4%.
High inflation in the United States and elsewhere makes it unlikely the Federal Reserve, the European Central Bank, and the Bank of England will fully pause what has been a joint turn towards tighter monetary policy.
Fed officials said as much in the hours after the invasion, with U.S. policymakers citing what one called the “robust” case for raising interest rates from the near zero level set to fight the pandemic.
“Underlying demand is strong. The labor market is tight. Inflation is high and broadening,” said Richmond Federal Reserve bank president Thomas Barkin. Despite the events in Ukraine, “I don’t think you are going to see much change to the underlying logic…But this is uncharted territory so we will have to see where the world goes.”
AN INFLATION AGGRAVATOR
Still, analysts said the new level of uncertainty brought on by Russia’s actions could put policymakers in a more cautious mode, likely to settle at the margins for a bit less policy tightening than a bit more.
“The sharp increase in uncertainty and downside risk…weighs on the side of being careful without vetoing the process of policy normalization,” wrote analysts with Evercore ISI.
The Fed would now likely limit itself to a quarter percentage point rate increase at its March meeting, ruling out the half point hike some policymakers have favored, they wrote. The Bank of England might also pare its next expected increase, and the ECB delay making any firm promises about its tightening plans.
Local conditions and the length and depth of the conflict may matter.
Evercore ISI’s analysis, for example, noted that Italy was “exceptionally vulnerable” to disruption in natural gas supplies, a fact that could slow ECB tightening plans.
Yet the major economies on the whole will now almost certainly be facing stronger inflation pressures than they anticipated before the invasion.
“On any horizons beyond the very near term, the impact of the stagflationary shock is ambiguous and could be net hawkish,” they wrote. “The textbook play is to look through a price level shock, but that is difficult in current conditions, when a series of prior price level shocks has already delivered a phase of high inflation.”
Global central banks were on the same page. Ukraine may reshape that