Inflationary pressures in US, weakening euro, and the Bank of Japan's dovish stance

Federal Reserve Chair Jerome Powell (Reuters)

Inflation is poised to accelerate further in the months ahead as Russia's war against Ukraine drives up the costs of crude oil and other commodities. The broad rise in prices reported by the US Labor Department of the US on March 10 led to the largest annual increase in inflation in 40 years. Inflation was haunting the US economy even before Russia's invasion of Ukraine on February 24.

The US Federal Reserve and the Bank of Japan have policy meetings next week. While the Fed is certain to hike rates, the BOJ is set to remain an outlier and hold onto a dovish stance on monetary policy. Other major central banks across the globe are eying to raise interest rates to combat quickening inflation.

The dollar has gained 1.3 percent on the Japanese currency this week, its biggest weekly gain since October 2021. And, the euro has been hurt by the impact of the conflict in Ukraine and resulting higher energy prices.

U.S. consumer prices accelerate, year-on-year CPI hits 40-year high

The US consumer prices surged 7.9 percent year-over-year in February, culminating in the largest annual increase in 40 years. In the 12 months through February, the CPI shot up 7.9 percent, the biggest year-on-year increase since January 1982. Soaring inflation is wiping out wage gains. Inflation adjusted average hourly earnings fell 2.6 percent on a year-on-year basis in February, the Labor Department said.

The Federal Reserve is expected to start raising interest rates on March 16. With inflation nearly four times the U.S. central bank's 2 percent target, economists are expecting as many as seven rate hikes this year.

While the market fully expects the central bank to raise the Fed funds target rate by 25 basis points at the conclusion of next week's monetary policy meeting, the CPI data suggested the FOMC could move "more aggressively" to curb inflation in the upcoming year, as promised by Fed Chair Jerome Powell last week.

Fed's Powell backs 25 bps rate hike, open to bigger moves later

Federal Reserve Chair Jerome Powell, balancing high U.S. inflation against the complex new risks of a European land war, said on March 2 the central bank would begin “carefully” raising interest rates at its upcoming March meeting but be ready to move more aggressively if inflation does not cool as quickly as expected.

But he said for now the Fed was proceeding largely as planned to raise the target overnight federal funds rate and reduce the size of its balance sheet in order to tame inflation that is currently the highest it has been since the 1980s.

Powell said he will back a quarter point rate increase when the Fed meets March 15-16. Ad, the Fed chief said he was ready if needed to use larger or more frequent rate moves if inflation does not slow.

ECB to turn off money taps at Ukraine 'watershed' moment

The European Central Bank (ECB) on March 10 said it will stop pumping money into financial markets this summer, paving the way for an increase in interest rates as soaring inflation outweighs concerns about the fallout from Russia's invasion of Ukraine.

The euro touched a 22-month low of $1.0804 earlier in the week, raising the prospect of additional imported inflation pressure. The single currency is widely seen as a gauge of Europe's biggest security crisis since 1945.

ECB President Christine Lagarde said the conflict was a "watershed for Europe", which would curb growth but boost inflation.

"The Russia-Ukraine war will have a material impact on economic activity and inflation through higher energy and commodity prices, the disruption of international commerce and weaker confidence," she said at a news conference.

But the waning impact of the coronavirus pandemic on the economy, improved labour market conditions and the prospect of an easing of supply chain bottlenecks all showed the euro area was in fundamentally healthy shape, Lagarde added.

While the bank announced modest growth downgrades for this year and next, it ramped up inflation forecasts more strongly and now expected price growth of 5.1 percent in 2022 (more than double the ECB's 2.0 percent target), 2.1 percent in 2023 and 1.9 percent in 2024. On an annual basis, it was expected to grow 3.8 percent in 2022 and 2.5 percent in 2023, from 3.9 percent and 2.5 percent predicted in February.

ECB to wait until Q4 to raise rates despite rampant inflation

The European Central Bank will wait until the end of this year for its first interest rate rise in over a decade. Investors now expect it to increase its rate on deposits by nearly 50 bps by the end of the year.

ECB said any adjustments in interest rates would take place "some time" after the end of asset buys, a change from the previous formulation that purchases would end "shortly before" a rate move.

"Obviously 'some time after' is an open time horizon which is data dependent," Lagarde said, when asked repeatedly what that meant for the timing of a first rate hike.

The statement from the ECB, which left the door open to an interest rate hike before the end of 2022 as soaring inflation outweighs concerns about the fallout from Russia's invasion of Ukraine, briefly sent the euro higher, before market sentiment turned negative.

EU was swift in imposing sweeping sanctions

European Union leaders will phase out buying Russian oil, gas and coal, a draft declaration showed on March 10, as the bloc seeks to reduce its reliance on Russian sources of energy, following a ban from the United States. The United States and its allies have imposed harsh sanctions on Moscow, with Biden on March 8 banning imports of Russian oil into the United States. Russia is the world's second-largest crude oil exporter.

BOJ in dilemma

Painful price hikes are in the offing in Japan, with consumers paying more for everything.

The Federal Reserve is expected to start raising interest rates on March 16.

Consumer price inflation looks set to accelerate in the coming months toward 2 percent and may exceed the target set by the Bank of Japan, economists say.

The bad news is that the recent bout of inflation may not be the kind of price rises that the Japanese central bank would have wanted to see, because it has been -- and will likely be -- led by higher commodity prices, exposing the vulnerability of the world's third-largest economy that relies heavily on energy imports.

The BOJ, which has been keeping its ultraeasy policy intact, is in a bind while consumers feel the cost of living getting higher and tepid wage growth hurts spending.

The Bank of Japan may downgrade its economic assessment at next week's policy meeting as a spike in Omicron COVID-19 infections dealt a bigger-than-expected blow to consumption. The central bank may also warn of heightening economic risks from the Ukraine crisis, which threatens to dent consumption.

The BOJ will conduct a quarterly review of its growth and inflation projections at its April 27-28 meeting.

The recent spike in oil and grain prices deals a particularly heavy blow to resource-poor Japan, while a projected slowdown in global growth threatens to cripple its export-reliant economy.

(With inputs from Reuters)