Will US and UK central banks raise interest rates despite the threat to growth?

Will the Federal Reserve raise interest rates for the first time since 2018?

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,” said Andy Brenner, head of international fixed income at NatAlliance Securities.

“Inflation is going to get worse before it gets better. But the Fed is limited in how quickly it can raise rates,” he added. Kate Duguid

How will the Bank of England respond to the Ukraine conflict?

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.

UK inflation hit a 30-year high of 5.5 per cent in January, well before the impact of the dramatic rise in oil prices sparked by the outbreak of war and western sanctions on Moscow was felt. Given a sizeable minority of the BoE’s rate-setting committee voted for an extra-large half percentage point rate rise last month, “there is a degree of momentum for another increase”, according to Philip Shaw, chief economist at Investec.

“We are taking the view that at this point, the [BoE] is more concerned about higher inflation than the risk of economic weakness, particularly with interest rates still very low by historical standards,” Shaw said.

The BoE would hardly be swimming against the tide. The European Central Bank last week announced a faster reduction in the scale of its asset purchase programme, while the Fed is expected to raise rates.

Beyond Thursday’s meeting, the prospects for further rate rises are likely to depend on the extent to which oil price rises feed through to other areas of the economy, particularly wages. Markets are currently braced for a further five interest rate rises before the end of 2022.

The BoE “may well raise rates gradually until there are signs that the economy is slowing, that inflation pressures may be ebbing or that it is clear that pay growth remains relatively modest”, said Shaw. Tommy Stubbington

Will the gold price hit an all-time high?

Increased volatility across global financial markets since Russia’s invasion of Ukraine has encouraged investors to look again to gold as a haven asset, its traditional role in periods of turmoil.

The gold price peaked at nearly $2,070 this week, trading within touching distance of an all-time high of $2,072.50 hit in August 2020, according to Refinitiv data. But it later retreated below $2,000 — a key resistance level — despite fighting intensifying across Ukraine, leading to questions about the longevity of the precious metal’s rally.

Gold’s ascent was supported by heavy buying from exchange traded fund managers. Gold-backed ETFs have seen a marked increase in demand so far this month, with investors adding 96.2 tonnes to their total holdings at a cost of more than $6.1bn by March 9.

That has taken net investor inflows to almost $11bn so far this year, pushing the value of assets held in gold ETFs to $240.5bn, according to the World Gold Council, a trade body which represents gold producers.

Geopolitical tensions have historically provided only a shortlived boost for gold. But Suki Cooper, precious metals analyst at Standard Chartered bank in New York, said a deeper shift in investor sentiment appeared to be unfolding as a result of the war in Ukraine and worries about the impact of inflation on other asset classes.

Goldman Sachs last week raised its forecast for the gold price to $2,500 over the next six months, up from $2,050 previously. Goldman said it expected to see demand for gold increase this year from ETF investors, consumers in Asia and central banks.

Moscow is set to buy all of Russia’s gold output this year after the Kremlin was blocked from accessing any foreign currency reserves held in offshore centres. This sanction on Russia is likely to encourage other central banks and governments to reconsider the place that gold holds in their foreign exchange reserves.

“Central banks globally have both strong diversification and geopolitical reasons to shift [more] reserves into gold,” said Mikhail Sprogis, an analyst at Goldman. Chris Flood