WITH the Russian invasion of Ukraine, it is only going to be a matter of time before the devastating impact will be felt not just by Ukraine and Russia, but also the global economy that has been recovering unevenly following the Covid-19 pandemic.
More downside risks on global economy have emerged.
Just like in 2021 where there were downward revisions to global growth due to the pandemic, a similar pattern seems to be emerging in 2022. This time around, it will be induced by geopolitical tensions besides the impact from the rollback of stimulus measures and concerns over new variants that could disrupt the recovery due to lockdowns or targeted movement control orders.
Following the Russian incursion into Ukraine, there are growing risks of a new frontline of conflict taking shape in Europe. Much will depend on what Russia intends to do.
As of now, the Russians’ shelling in Ukraine is deemed a “special military operation” aimed at the “demilitarisation and denasification” of Ukraine, bringing it to a surrender and come under Russian control.
Russia has warned the United States and the North Atlantic Treaty Organisation (Nato) not to interfere or they would face “consequences”.
A lack of clarity and uncertainty have raised the risk levels and the eyebrows of Nato, questioning if the alliance can respond significantly and effectively.
Should Russia succeed in taking over Ukraine and keep bases in neighbouring Belarus, would that mean a growing chance for Russia to extend the borders of the Baltics and Poland to Slovakia, Hungary and northern Romania?
The corridor that separates Lithuania and Poland from Russian forces in Belarus from Kaliningrad, the Russian territory on the Baltic Sea that is stuffed with missiles capable of firing conventional or nuclear warheads into the heart of Europe, is only about 97km.
Will it be tougher for Nato to defend its eastern flank? Nato’s risk has suddenly increased.
A possible conflict with Russian forces in Europe or elsewhere, like the Black Sea, the Sahel, Libya or Syria can potentially emerge. There could be countries in other areas that may also attempt to test and provoke the United States. This would be dangerous and is an ongoing issue.Geopolitical uncertainty comes at a tough time for the world’s central banks. Several central banks have already begun the process of tightening their respective monetary policies to address the record-high inflation.
For instance, the Bank of England (BoE) stared firing the rate hike gun by raising the policy rate at end-2021 and has instituted two hikes in its last two meetings. Another two rate hikes are on the cards prior to the Russia-Ukraine tensions.
Aggressive move
The US Federal Reserve (Fed) is expected to move aggressively on its hiking cycle with about six rate hikes in 2022, starting with a more likely 50 basis points (bps) in March.
And the European Central Bank (ECB), who has lagged its peers in terms of a hawkish pivot, is now expected to begin tightening late in 2022, with at least two hikes given that the region’s inflation is running at a record high.
The risk behind the conflict in Ukraine could lead to an even greater pressure on central banks to either be more aggressive or less.
For instance, if oil and gas prices continue to trend higher, some quarters hold the view that the central banks would be forced to accelerate their pace of tightening.
In this case, the Fed is expected to a double its rate hike at March’s lift-off date. Meanwhile, there are others who believe that the Fed will only raise 25bps during the March meeting. We have now lowered our probability for a 50bps hike in March to a 40% chance from previously 60% while maintaining a 25bps hike.
In the case of ECB policymakers, there has been a divergence with regard to the rate hike following Russia’s latest escalation.
For example, Austrian central bank governor Robert Holtzmann has suggested that the ECB could make its first post-pandemic rate hike this summer before the end of its bond-purchase programme. He also cited the need for a second rate hike before the end of the year.
There are other ECB policymakers who felt that the central bank should keep its options open and assess the Russia-Ukraine crisis.
Data-driven
Any decision by the central bank should be in a “data-driven, forward-looking” approach in the face of the current scale of uncertainty.
Domestically, the earlier expectations were for Bank Negara to likely raise the overnight policy rate by 25bps in the second half of 2022.
It would be mainly to build an economic buffer and reduce the interest rates differential that could weigh on the ringgit against the US dollar.
Domestic inflation is likely to be well managed as we do not have an inflation target like the Fed, ECB, BoE or Bank of Japan.
Wait-and-see attitude
However, with the current geopolitical tensions, just like all other centrals banks, it is likely that Bank Negara will continue to adopt the wait-and-see attitude that would be supported by the potential incoming data.
For now, the one rate hike view in the second half of 2022 still remains, while we have placed a low probability of 30% for two rate hikes.
When we entered 2022, we were of the view that central bankers will be experiencing challenging times and facing a very difficult balance.
There is a high probability for policy errors. Should the central banks tighten too quickly and slow down the economy too fast or tighten too slowly, they could risk losing control of their medium-term inflation expectations.
Hence, the Russian invasion of Ukraine certainly heightened the level of confusion among the policymakers.
Lack of clarity
This is simply because there is a lack of clarity as to how this whole conflict will pan out, plus added upwards pressure on energy prices that will continue to push the expected inflation peak into new highs.
Ultimately, we think central banks are working with a relatively blunt toolkit here.
Just as we saw the central banks being unable to solve the semiconductor shortage in 2021 that applied significant upward pressure on the prices of goods, we feel that the central banks will not be able to solve higher energy price issue via rate hikes in 2022.
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