Central Banks Unlikely To Change Course On Rate Hikes Due To Ukraine Conflict: BMO

Global markets are puking as the Ukraine-Russia conflict presents global uncertainty and risk. BMO chief economist Douglas Porter wrote a special brief to clients today, explaining this doesn’t change much at this point. BMO still expects the Bank of Canada (BoC) and the US Federal Reserve to hike interest rates in March. The influence on commodity prices potentially boosts the need for higher interest rates.

Bank of Canada Expected To Hike Rates Next Week

The BoC is still forecast to hike interest rates next week, possibly with more reason. BMO reiterated they expect a full (25 bps) hike to the overnight rate at the March 2 meeting. At this time, the bank doesn’t see the crisis spilling over beyond Ukraine. If that occurs, it might need to be reviewed. The risk of uncertainty means the unlikely scenario of a 50 bps hike in Canada can be safely “put to bed.”

The bank highlights Canada has little direct trade with Ukraine or Russia. However, the conflict is already sending shockwaves through commodities, which will hit Canada. “The most important impact on Canada’s economy from the developments in Ukraine is through the commodity price channel, and specifically through the rise in oil prices,” says Porter.

Inflation In Canada and The US Rises 0.4 Points For Every $10 WTI Oil Rises

Crude prices influence consumer prices more than many assume, meaning higher inflation. Crude is both a basic input for many goods, as well a direct influence on transportation costs. BMO estimates every $10 rise in WTI oil drives headline inflation 0.4 percent higher in Canada and the US. January reported a multi-decade inflation high, and it only averaged $83 per barrel. The impact of rising prices wasn’t even fully realized at that point. 

“Thus, if prices hold at current levels, or head higher, this factor alone could bump headline inflation by roughly 0.6 ppts,” Porter estimates.

“Indeed, the sharp move higher in energy prices only reinforces inflation concerns, though there’s the added layer of growth risks as well due to the extent of the increase in oil prices and because of the Russia/Ukraine conflict itself. We’re not changing our forecast for the BoC, but uncertainties have ramped up,” he adds. 

US Federal Reserve Isn’t Changing Course Either

The US Federal Reserve is forecast to remain on course for interest rates for a similar reason. Higher inflation threatens the credibility of the global reserve currency. The Reserve has already said they believe high inflation is due to an inflationary shock. This requires policy normalization, or it risks an inflationary spiral. Though increased uncertainty can slow the rate at which they normalize.

“With the Fed already being perceived as ‘behind the curve’, we doubt these events will stay the Fed’s hand next month,” said Porter. Though he sees talk around the 50 bps super hike to be unrealistic.

Separately, the head of the Richmond branch of the US Federal Reserve weighed in. Speaking to the Maryland Chamber of Commerce, Branch President Tom Barkin explained he sees higher rates. 

“… I think it is timely for us to normalize policy… The logic for that is underlying demand is strong. Labor market is tight. And inflation has been high and broadening. The logic for normalization I think rests on those premises,” explained Barkin.

“We are going to have to see whether this Ukrainian situation changes that narrative. And I just think time will tell,” he said.