Interest rates are slated to rise several times in 2022. Does the Ukrainian crisis shift the thinking from central bankers?
- The situation in Ukraine has created some uncertainty on interest rates
- The war will push up inflation in the shortterm, but higher interest rates could add to the cost of living crisis
- Financial markets have drifted away from the stated aim of central bankers.
For some time, it has looked like the direction of monetary policy was clear: with inflation edging close to 8%, low unemployment and rates still close to zero, interest rates had to rise. However, the situation in Ukraine has created some uncertainty as policymakers weigh their options.
It seems evident that the war will push up inflation in the short-term. Oil and gas prices have been rising as supply is constrained. This would seem to suggest that policymakers should stay the course, continuing their path of rising rates. However, they also need to be aware of the heavy toll on the cost of living. Raising rates would add to the burden for households and, potentially, damage economic growth.
Financial markets have drifted away from the stated aim of central bankers. While central bankers say they will stick to their current path, markets are increasingly assuming that they will be forced to back down and keep rates low. There is a growing assumption that policymakers will not want to risk the current economic recovery by raising rates.
Thomas Beckett, CEO of Punter Southall Wealth Investment Management, calls this a ‘Hobson’s choice’ – “either rates go up and weight upon economic growth, or they can’t go up and inflation could become “unanchored”, leading to greater issues later this decade.”
Events beyond their control may ultimately make the decision for policymakers. There are more optimistic signs on peace talks between Ukraine and Russia, which may bring about a de-escalation of the conflict. Equally, the International Energy Agency has stepped in to release more oil onto the market with the aim of stemming rising energy prices. Also, if economic growth starts to slide, it may naturally bring about lower inflation.
Beckett believes that “somewhere in between” is the most likely outcome, with central banks adopting a marginally slower approach to interest rate rises. However, investors shouldn’t expect the imminent rises from the Bank of England or the Federal Reserve to be put on hold.
The Ukrainian crisis is unlikely to blow central banks off course, in spite of its impact on energy prices. It may, however, cap any ambitions for the faster rate rises some central bank committee members have sought. Rate rises are still on the cards for the year ahead.
