Howard Schneider, Mark John

(Reuters.) – While the global central bank’s well-scripted shift towards tighter post-pandemic monetary regulation has been questioned, Russia’s invasion and occupation of Ukraine have created a new geopolitical crisis that will be felt in different parts of the world. It also poses risks for global economic growth.

There were two risks: a spike in oil prices to over $100 per barrel and longer-term uncertainties about the impact of a revival of European war on confidence, trade, and the financial sector.

Many analysts believe that this has raised the possibility that central banks will continue to see inflation rise while economic growth slows down. This is a problem that cannot be solved with traditional central bank strategies.

Oxford Economics analysts stated that “for the major advanced economies central banks, the intensification war now leaves them in an distinctly worse situation.” The high inflation starting point…will be difficult for central banks not to take into consideration the immediate upward pressures on inflation. However, central banks will recognize that new developments may increase the risk of low inflation by 2023 and 2024 because there is a weaker outlook for growth.

Oxford analysts pointed out that Europe will be the hardest affected by this development, aside from Russia. Their forecasts for average headline Consumer Price Index inflation will see it rise to 4.6% next year, and fall sharply to 1.3% by 2023. The global CPI was upped to 6.1% by the agency, which previously forecasted 5.4%.

The high inflation rate in America and other countries makes it highly unlikely that the Federal Reserve, European Central Bank and Bank of England will stop their joint move towards tighter monetar policy.

The Fed’s officials confirmed this in hours following the invasion. U.S. policymakers made a strong case to raise interest rates above the nearly zero level that was set for fighting the pandemic.

“Underlying, demand is high. There is a tight labor market. Thomas Barkin, president of Richmond Federal Reserve Bank said that inflation is rising and expanding. 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.”

INFLATION AGGRAVATOR

Analysts still believe that Russia’s new uncertainty could cause policymakers to be more cautious and settle for less tightening.

Evercore ISI analysts wrote, “The stark increase in uncertainty…weighs against the side of caution without vetoing policy normalization.”

They wrote that the Fed will likely restrict itself to a quarter percent rate hike at its March meeting. This would eliminate any half-point rise some policymakers had favored. The Bank of England could also trim its next anticipated increase. However, the ECB may delay making firm statements about tightening its plans.

The local context and length or depth of conflict could be crucial.

Evercore ISI’s analysis of Italy, for instance, found it “exceptionally susceptible” to supply disruptions, which may slow down ECB tightening.

But the inflation pressures will be much greater for the main economies than was anticipated.

The authors wrote, “On any horizontal horizons above the very short term, the effect of the shock to stagflation is ambiguous” and that it could have a net hawkish impact. The textbook approach is to view a price shock through the lens of current circumstances, which is problematic when there have been a number of price shocks that has delivered high inflation.