Feb 15, 2022 - Economy & Business

War in Europe would put central banks in a bind

Credit: Axios Visuals. Source: FactSet
Credit: Axios Visuals. Source: FactSet

If Russia invades Ukraine, the economic ripples would likely spread worldwide — and make for a tricky situation for global central bankers.

  • War in Europe would further strain commodity markets and supply chains, fueling higher inflation, while also acting as an impediment to global recovery.

Why it matters: The prospect of armed conflict is already making markets jumpy. If it happens, it would also create a policy bind.

The big picture: International crises typically cause a flight to quality — meaning a massive inflow of money into safe assets. That would tend to drive the dollar up and interest rates on Treasury securities down.

  • Meanwhile, the Federal Reserve, European Central Bank, and other leading central banks will be reluctant to engage in monetary tightening at a time of geopolitical peril.
  • In that sense, the Fed would want to move more gingerly as it considers how much to raise rates next month, and the ECB would be even more devoted to its current policy of gradualism in withdrawing easy money.

Yes, but: Armed conflict in Eastern Europe also threatens to make the advanced economies' inflation problem worse. That means the Fed and ECB would find themselves in the awkward position of backing off their anti-inflation measures at a time the pain of inflation is becoming more severe.

  • Beyond higher commodity prices, any transportation or energy supply disruptions in Eastern Europe could rapidly cause problems for German export industries they supply, adding to the litany of global supply challenges.

One countervailing effect: To the degree the flight to quality drives up the dollar, it would diminish inflationary pressure in the United States.

What they're saying: "We need to be open about what we can and cannot do as a central bank,” ECB President Christine Lagarde told the European Parliament Monday. “For example, our monetary policy cannot fill pipelines with gas, clear backlogs at ports or train more lorry drivers.”

The bottom line: Look for central banks to try to cushion any economic damage from a Ukraine crisis — but to find themselves with little room to maneuver.

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