Nicholas Spiro

Macroscope | Spiralling inflation, economic slowdown and a drawn-out struggle with Russia: the Fed is facing a lose-lose situation

The US Federal Reserve knows it must bring inflation under control, but fears the damage higher interest rates will do to a still-fragile economy

Now, with tougher economic sanctions against Russia and a spike in fuel prices all but inevitable, the necessary inflation-curbing policies are even less welcome

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A pressure gauge is seen at a gas compressor station near Kiev, Ukraine. A Russia-Ukraine war is likely to send shockwaves through global energy markets. Photo: Reuters

Nicholas Spiro

Published: 2:31pm, 24 Feb 2022

Spare a thought for the US Federal Reserve. Even before Russian President Vladimir Putin’s decision on Thursday to launch a full-scale invasion of Ukraine, setting the stage for more punitive retaliatory Western sanctions, the world’s most influential central bank faced an acute policy dilemma.

Having been dangerously behind the curve in tackling the surge in inflation, which hit a 40-year high of 7.5 per cent year on year last month, the Fed was forced to accelerate its timetable for withdrawing monetary stimulus. By winding down its asset purchases earlier than planned, the central bank gave itself more flexibility to raise interest rates sooner, and at a faster pace, than previously envisaged.

The Fed’s hawkish pivot caused a dramatic repricing of estimates for US rate hikes this year, with as many as seven increases priced in earlier this month, including a supersized rise of half a percentage point at the Fed’s policy meeting next month.

Yet, no sooner did the Fed take a more aggressive approach to countering inflation than divisions emerged within the central bank – amplified by worrying signals from bond markets – over the pace of tightening and how high rates can rise without damaging the economy.

Tensions between a sharper-than-expected rise in borrowing costs and an increasingly uncertain economic environment have intensified since Putin recognised two breakaway regions in eastern Ukraine and ordered a full-blown attack on the country, plunging Europe into its biggest security crisis since the second world war.

The threat of more economically significant sanctions that could disrupt Russia’s crucial energy supplies heightened concerns about a “weaponisation of commodities” by Russia, which accounts for 40 per cent of Europe’s natural gas imports and a third of its crude oil imports.