Central banks are ready to deal with the risk of rising energy prices

On March 18, both the US Federal Reserve (Fed) and the Bank of Canada decided to keep the reference interest rate unchanged. The Central Banks of Japan, England, Europe, Switzerland and Sweden also made a similar decision on March 19.

These agencies emphasized that they are vigilant against the risk of rising energy prices causing inflation to spread throughout the economy. “The conflict in the Middle East makes the outlook significantly more uncertain, increasing the risks of inflation and slowing economic growth,” the European Central Bank (ECB) said.

At the following press conference, ECB President Christine Lagarde said the euro area is resilient. Inflation is currently low, meaning the region is “in a favorable position” to cope with “a major shock on the horizon”.

The bank raised its inflation forecast this year to 2.6%, higher than the target of 2%, and announced scenarios showing that this figure could decrease again if the shock is only temporary. However, if the disruption is prolonged, inflation could reach 4.8% next year.

If the conflict is not resolved soon, ECB officials are expected to begin discussing the issue in April and may tighten policy at the June meeting, ECB sources said. Reuters said.

Bank of England Governor Andrew Bailey also said the agency must react if the impact on UK inflation persists. However, Bailey lowered market expectations about the possibility of increased profits.

Investors currently forecast that the BOE will adjust interest rates twice this year, each time by 25 basis points, up from just once before the meeting. “People should not rush to conclusions that we will raise interest rates. Today we send a very clear message: keeping it unchanged is the right choice,” Bailey said in an interview on March 19.

Many global central banks have been criticized for their slow action during the post-pandemic inflation wave and the Russia-Ukraine conflict. So this time they are determined to cool prices without derailing economic growth. The top priority is to avoid the stagflation scenario – slow growth with high inflation.

Iran’s attacks in the past few days have caused widespread damage to the world’s largest gas plant in Qatar, and also hit many infrastructure in the Gulf region. This happened after Israel attacked Iran’s gas fields. These moves could cause energy supply disruptions for longer periods of time.

However, US Federal Reserve Chairman Jerome Powell said that currently, it is impossible to assess the impact of rising energy prices. “The impact of developments in the Middle East on the US economy is still unclear. In the short term, rising energy prices will push up general inflation, but it is too early to assess the scale and duration of the potential impacts on the economy,” he said.

Financial markets have reduced expectations about the possibility of the Fed lowering interest rates. They even increase their bets on the opposite move. Brent oil price at one time increased to 119 USD per barrel on March 19, but is currently around 106 USD.

Governor of the Bank of Japan (BOJ) Kazuo Ueda also said that he does not rule out the possibility of raising interest rates in the short term, if the impact from the increase in oil prices on growth is only temporary. “Recent developments may increase businesses’ costs, affecting the selling price of goods more than in the period after the Russia-Ukraine conflict,” Mr. Ueda said at a press conference.

Bank of Canada Governor Tiff Macklem also gave a similar message. “If energy prices remain high, we will not let their impact spread and become persistent inflation,” he said.

Earlier this week, the Central Bank of Australia raised interest rates to a 10-month high, and warned that rising oil prices created “significant” inflation risks. Even the Central Bank of Brazil – whose interest rate is among the highest among major economies, only cut it by 25 basis points, bringing the reference rate down to 14.75%. This decrease is lower than expected.

The Swiss National Bank and Sweden’s Riksbank both kept interest rates unchanged, while warning that it was unclear how the conflict would impact the economy.

“This latest escalation is a turning point for the market. Because the conflict is no longer just a military issue or the Strait of Hormuz anymore. When the energy grid is attacked, the risk of stagflation will increase,” concluded Charu Chanana – investment strategist at Saxo Bank.