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Economic Report: Ukraine invasion clouds forecast for U.S. economy and complicates Fed’s inflation-fighting strategy

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The Russian invasion of Ukraine is unlikely to sabotage the U.S. economy so long as the conflict doesn’t spread, analysts say, but surging oil prices could push inflation higher and complicate efforts by the Federal Reserve to get upward price pressure under control.

U.S. stocks
DJIA,
-1.95%

SPX,
-0.99%

sank in Thursday trades and the price of oil briefly surged above $100 a barrel for the first time since 2014 after Russia launched a broad assault on Ukraine.

The most immediate threat to the economy is the cost of oil, since it’s a big contributor to higher prices. The U.S. is already experiencing its worst bout of inflation in 40 years, and rising oil prices could make the situation worse.

The cost of living, measured by the consumer price index, rose at a 7.5% yearly pace as of January.

Economists at BMO Capital Markets estimate that every $10 increase in the price of oil adds about 0.4 percentage point to the rate of inflation. Oil prices have already increased by one-third in the past year.

The Fed is planning to embark on a series of interest-rate increases starting in March to try to cool down the economy and squelch inflation. Now the Fed has to weigh how aggressively to act this year.

The Ukraine conflict could deal a blow to global economic growth, on the one hand, and support a less aggressive Fed strategy. Higher interest rates would exacerbate an economic slowdown.

Yet the conflict could also boost already high inflation and force the Fed to raise rates faster. Russia is one of the world’s biggest producers of oil, wheat and other key commodities whose prices have soared.

See: Ukraine invasion sends wheat, corn and oil soaring because Russia is a ‘commodity superstore’

“Much will depend on the European economic consequences of the current conflict and its potential escalation,” BMO economists wrote.

Several senior Fed officials on Thursday emphasized that the central bank still needs to raise interest rates soon, even amid the Ukraine crisis, but said the situation in Eastern Europe bears close watching.

“We’re going to have to see whether this Ukrainian situation changes that narrative. And I just think time will tell,” Richmond Federal Reserve President Tom Barkin told the Maryland Chamber of Commerce.

Fed watchers say the outbreak of fighting all but ensures the central bank will raise its benchmark short-term rate, now near zero, by a quarter-point next month, rather than move more aggressively.

“The invasion makes a 0.5-percentage-point hike at the Fed’s March meeting much less likely,” said chief economist Bill Adams at Comerica.

A prolonged and widening conflict in Ukraine — the worst-case scenario — would force the central bank to walk a tightrope with small margin for error.

“The Fed could be raising interest rates more aggressively at the same time that global growth is slowing, increasing the likelihood of a central-bank policy misstep,” said Gus Faucher, chief economist at PNC Financial Services.

ETF Wrap: How can investors navigate a perfect storm in the stock market with ETFs, as Putin launches Ukraine invasion, Fed battles inflation?

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