The war in Ukraine adds more complexity to the Fed’s tough fight against inflation
Russia’s invasion of Ukraine complicates matters for the US Federal Reserve (Fed), as uncertainty about its impact on the global economy adds more complexity to the US central bank’s already difficult fight to contain the rise in prices.
Soaring energy and food costs have pushed inflation in the world’s largest economy to its fastest pace in four decades, and the Fed is set to raise the benchmark borrowing rate in March to extinguish the fire.
But while the Russian-Ukrainian conflict drives up oil prices further, it also threatens to undermine economic recovery from the COVID-19 pandemic.
“It’s just been a time that was always going to be all the more difficult,” Erica Goshen, a former senior Fed official, told Agence France-Presse (AFP).
Fed policymakers “will be watching the data very carefully. It adds some additional considerations into the pot,” said Goshen, senior economics adviser at Cornell University’s School of Industrial and Labor Relations.
Crude prices briefly topped $100 a barrel on Thursday after Russia launched its invasion, the first time it topped that benchmark since 2014.
And wheat prices could also soar, as Ukraine is one of the world’s leading grain exporters.
The Fed cut the benchmark lending rate to zero at the start of the pandemic and flooded the financial system with liquidity in an effort to stave off a severe recession.
Coupled with massive federal spending programs, this effort has been largely successful: the economy has rebounded rapidly, growing 7% in 2021.
But strong demand, supply chain issues and labor shortages combined to push the Fed’s preferred inflation index to 6.1% in the year ended in January, well above the 2% target.
To contain the wave of energy, housing, car and food price hikes, Fed officials have been bracing financial markets for weeks for upcoming rate hikes, hoping to stage the elusive “soft landing” and avoid tipping the economy into recession.
Fed officials typically stick to generalities and indices, leaving the markets to interpret their exact meaning, but in an unusually blunt speech on Thursday, Fed Board Member Christopher Waller said that there could be a “strong case” for a half-point increase in the benchmark lending rate. on the first hike next month, twice the usual movement.
But the situation in Ukraine may change his thinking ahead of the March 15-16 meeting of the Federal Open Markets Committee (FOMC).
“Advancing” a half-point increase “would help convey the committee’s resolve to tackle high inflation,” he said.
“Of course, it is possible that the state of the world will be different as a result of the Ukraine attack, and that may mean that a more modest tightening is appropriate, but that remains to be seen,” Waller explained. .
Goshen said part of that “tough talk” is to convince markets that the Fed is serious and start moving market rates and calming inflationary pressures without being overly aggressive.
“Ideally, they would achieve their goals without having to slow down the economy too much,” she added.
The central bank said it would allow inflation to stay above 2% for some time, but Goldman Sachs commodities analyst Jeffrey Currie warned that “any disruption in commodity flows raw materials from Russia and Ukraine could raise fears of an overshoot in US inflation and a subsequent hard landing.” .”
Markets will pay particular attention to Fed Chairman Jerome Powell, who will present his semiannual testimony to Congress on Wednesday and Thursday.
Kathy Bostjancic of Oxford Economics said the Ukraine crisis has changed her perspective, and she now expects the Fed to opt for a “more conservative” quarter-point rate hike, even as inflation continues to accelerate.
But she added that she is “closely monitoring wage growth, unit labor costs and the pricing power of companies, as they play a critical role in determining the magnitude and the rate at which inflation will slow later this year”.