Will Fed hike rates despite the threat to growth?

The US Federal Reserve is expected to raise interest rates despite the threat to growth posed by Russia’s invasion of Ukraine.

The US Federal Reserve is widely expected to raise interest rates by 0.25 percentage points at its meeting next week for the first time since slashing borrowing costs to zero at the start of the coronavirus pandemic.

In testimony before Congress earlier this month, Fed chair Jay Powell said the US central bank was prepared to begin a series of interest rate increases beginning in March, despite Russia’s invasion of Ukraine and the ensuing economic fallout.

Currently, the US futures market is fully pricing in a quarter-point raise in March, with another five expected over the remaining six meetings this year. That would leave the Fed’s key interest rate at roughly 1.5 per cent by December.

The hope is that higher interest rates will help quell inflation, which in February rose by 7.9 per cent year on year, the fastest pace in 40 years. While it may dampen some inflationary pressures, tighter monetary policy cannot deflate prices driven higher by external shocks such as the conflict in Ukraine, which has sent energy and other commodity prices soaring.

Powell is also expected to address concerns about US economic growth. High energy prices raise costs for companies and individuals. Tightening monetary policy too quickly in that environment could, in the worst-case scenario, tip the US into a recession.

In the case of inflation versus recession, I don’t care how bad inflation is, the Fed doesn’t want a recession because then that reverses all they’ve done with employment and the recovery.

Inflation is going to get worse before it gets better. But the Fed is limited in how quickly it can raise rates.

Investors expect the Bank of England to raise interest rates for the third time since the pandemic next week, despite the threat to growth posed by Russia’s invasion of Ukraine.