By Dhara Ranasinghe, Sujata Rao and Saikat Chatterjee

LONDON (Reuters] – While a war in Europe’s east flank may complicate the outlook for inflation and economic growth, U.S. Federal Reserve officials and other major central bank peers are expected to push forward with interest rate increases this month.

This is a fluid situation, where rate futures are whippedsawed and bond prices are influenced by competing impulses. There’s no way to know which one will win the battle. A war could threaten to undermine a global economic recovery. Or the inflation caused by an increase in oil prices. It’s difficult for central banks to ignore.

However, there are no expectations for big rate increases after Russia’s invasion and the sanctions that were imposed on Ukraine by Western countries.

A safety-seeking cash influx and subsequent bond rally have driven German 10-year yields below 0% Tuesday. Their counterparts in America, however, are down 30 basis points from their 2% levels two weeks ago.

Wednesday is the real test for March. On Wednesday, the Bank of Canada will deliver its first quarter point rate hike since 2018.

Inflation is at an all-time high of just above 5%, and the BoC pledged that it would be “forceful”. Markets see 90% likelihood of 25 bps inflation this month.

These five- to six rises are somewhat less aggressive that the six to seven expected moves a week ago. [BOCWATCH]

Both the Federal Reserve and Bank of England are expected to increase rates by quarter-points mid-March. Markets had expected that both the Federal Reserve and Bank of England would raise rates by a quarter point mid-March, but this was before the Ukraine crisis.

The money markets are now anticipating fewer than six Fed rate increases this year at 25 bps each, as opposed to the mid-February forecasts for 175 bps tightening.

Jim Caron is the chief fixed income strategist Morgan Stanley (NYSE:) Investment Management deemed the most recent events “a double-edged blade” due to the potential inflation threat of higher oil prices as well as the impact on economic growth that could be caused by war.

Caron explained that “there has been a recalibration in rate expectations” and it was evident with the pricing of a 50bps Fed increase for March.

“So the next question is to try and figure out the meaning for Fed.”

Because Russia-related growth setbacks in America are more likely here, the Fed’s dilemma is not as acute as it is for European counterparts. Inflation in the United States is currently at a 40-year high above 7%. However, latest data shows that unemployment rates are declining to levels seen since 1970.

BACKS AGAINST THE WALL

Britain has a similar situation with an added challenge: inflation and energy-linked slowdowns.

Although 25bps rate increases were nearly fully priced in on Tuesday for both the March and May BoE meetings, markets still see an approximately 10% increase in rates. However, this is despite doubts that have only recently creeped in.

There are currently four quarter point rate hikes for 2022 in total, against five last week and six by mid-February.

Colin Asher, senior Mizuho economist stated that “Different central bankers are in different boat but the Fed or Bank of England have to face the wall.”

Inflation is between 6% and 7%.

British consumer price inflation (CPI), which reached 5.5% in January was the highest level since 1992. Citi economists predict that CPI could rise to 8.1%, whereas the BoE anticipates it peaking at 7.25%.

British government bonds have been reacting more than money market, with yields on two-years falling 40 bps after Friday’s closing at 0.8%. On February 16, they reached an 11-year peak of 1.565%. After June 2016’s Brexit vote, the steepest fall in yields is since sanctions against Russia were announced.

Norway will also likely to increase rates on March 24, according to some reports.

DOVES HAWKS DOVES AGAIN

Before the Russian invasion, Moscow refers to as a “special operations”, even dovish bankers were subjected to inflation pressure.

Although the Reserve Bank of Australia held rates steady on Tuesday as anticipated, it suggested that war-related uncertainty could cause tightening to need for patience.

Inflationary pressures are mounting at the European Central Bank (ECB) – German CPI soared above 5% in February – but there are also economic growth risk.

Philip Lane, the chief economist of the ECB, stated that this conflict might reduce Euro zone economic output by 0.3%–0.4% in 2015.

The bank was preparing the markets for another stimulus cut at its March 10-meeting, but rate rise bets have shriveled. Two, or 10 bps, moves for 2022 are being priced, compared to 50 bps just after the February 3 ECB meeting.

The search for safer assets finally stopped the increase in Japanese longer-dated bond yields. This is a problem for Bank of Japan (BOJ), who targets yields of around 10% for 10-years.

Mizuho’s Asher stated that the BOJ is under less pressure now than they were before, referring to the meeting on March 18.