Key Takeaways
- A big week for central banks with the Bank of England, the Bank of Japan, the European Central Bank and the US Federal Reserve all holding meetings.
- However, a lack of clarity around events in the Middle East and their implications mean that policy is expected to remain on hold … for now.
- Whilst ‘on hold’, central banks will be monitoring data closely – particularly around the extent to which higher energy costs are feeding into core inflation.
- We anticipate a patient approach – central banks will be mindful that higher energy costs provide a natural brake on economic activity, which in turn should alleviate inflationary pressure.
- We don’t foresee an inflationary shock of the size associated with conflict in Ukraine, but are mindful that economic consequences will become more severe the more protracted the conflict is.
This week we focus on what is set to be a busy week for central banks, with institutions from all the G7 economies meeting over the course of the next five days. However, the expectation for the big four – the Bank of England, the Bank of Japan, the European Central Bank and the US Federal Reserve – is that nothing will change.
Central banks – like the rest of us – are very much in ‘wait and see’ mode. There is little clarity around the likely duration, scope and impact of the Iran conflict, thus making it hard to make a considered shift in policy. We have, however, moved from expectations around rate cuts this year to an environment of holding borrowing costs steady or even hiking rates.
Although we are not there yet, we are in a phase where we have moved from what the ECB’s Christine Lagarde would describe as a ‘good place’ to a ‘very uncertain place’. The central banks do, however, have some time to digest the data and take a measured approach to deciding what to do next.
When you look at the data, we have obviously seen inflation numbers reflect the energy price shock, with the oil price back up by around 20%. At the time of recording, oil is trading around $107 a barrel and as inflation feeds into energy prices it will ultimately make itself felt elsewhere. Central banks will be looking for signs that inflation is feeding through into core inflation – if and when that happens, the alarm bells will start ringing.
For now, patience is key and central banks will be wary of jumping the gun and making aggressive moves. This is because, ultimately, interest rates can’t counter higher energy costs and could do more harm than good. Historically, energy price shocks have proven to be a natural brake on global economic activity, which in turn should alleviate inflationary pressure.
It is also worth contrasting the current situation with the 2022 Russia/Ukraine conflict. At that point we already had inflation in the system following the Covid pandemic and resulting supply chain issues. We also had a much tighter labour market and looser monetary policy. This time round we are coming from a backdrop of easing inflation, tighter central bank policy and looser labour markets. As a result, I don’t think the inflationary shock will be as severe this time around. The flip side is that there remains plenty of uncertainty and we just don’t know how long the conflict will last.
So, in summary, we expect the big four institutions to keep rates on pause as they wait for greater clarity. In terms of geopolitics, indications are that both sides in the conflict are keen for some sort of resolution, so hopefully we get more certainty soon. In the meantime, events are already having economic consequences and the longer this goes on the more severe those impacts will be.
