Surging prices for fuel, food and housing have sent US inflation to the highest in four decades, and the Russian military offensive in Ukraine has made the situation worse, so the Federal Reserve is preparing to take action.
But the central bank’s efforts to put out the inflation fires will be complicated by the prospect the war and wide-ranging sanctions imposed on Russia will disrupt trade flows and undermine the US economic recovery.
The policy-setting Federal Open Market Committee held its two-day policy meeting last week, with an announcement set for March 16 when it is poised to begin raising the benchmark lending rate that was cut to zero at the start of the Covid-19 pandemic in March 2020.
That would be the first in a series of rate hikes, but amid the rising uncertainty, some economists think policymakers may move less aggressively than previously expected as they weigh the competing forces on the economy.
“The Fed is being tugged in two different directions by the massive increase in energy prices that’s taken place over the last few weeks,” David Wilcox, a former senior advisor to three successive Fed chairs, said.
While higher inflation justifies the tightening moves, “the reduction in purchasing power that households are experiencing . . . would call for a more accommodative stance of policy, a more cautious approach,” said Wilcox, now with the Peterson Institute for International Economics and Bloomberg Economics.
Markets are pricing in about six rate hikes this year, but Grant Thornton Chief Economist Diane Swonk expects seven, while Wells Fargo raised their forecast from five to six – which would still leave the policy rate below two per cent.
Prior to Russia’s invasion of Ukraine, some economists – and even some Fed officials – said the first move in the tightening cycle could be a half point increase to send a strong signal to markets that the central bank was committed to keeping inflation from raging out of control.
But Fed Chair Jerome Powell the previous week declared his intention to call for a quarter-point increase – a stunningly direct comment from a central bank chief, who typically keeps their plans close to the vest.
Wilcox said he was “thunderstruck” by the statement which tamped down speculation of a more aggressive move.
While Wilcox remains cautiously optimistic that inflation will come down, he stressed that the Fed will have to be “absolutely clear” that it will act as forcefully as necessary should price pressures accelerate.
And in the short term, economists warn that things will get worse before they get better.
“The disruptions we are seeing are adding fuel to a well kindled inflation fire that goes well beyond the energy sector and could touch much more of our daily lives,” Swonk said.
Supply chain snarls caused shortages of key products as the global economy was returning to normal from the pandemic, and while the increases initially were driven by cars and housing, energy prices have spiked as well, especially in the past month.
The annual consumer price index in February hit 7.9 per cent.
The IMF the previous week warned that the fallout from the war will slow global growth, but the US economy enters the latest crisis in a strong position with low unemployment after expanding by 5.7 per cent last year.