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Raising rates during geopolitical turmoil is usually not a good thing. The source of the most recent spurt in consumer prices is now clearly tied to the events in Ukraine and Russia, two nations that are major sources of basic commodities such as wheat and oil. As the war rages on, so does the prices of these two staples, along with many other raw materials. In addition to the array of sanctions aimed at the heart of the Russian financial sector, we are hearing about hundreds of decisions made by individual corporations regarding commercial relations with Russian corporations worldwide. The impact of sanctions is not without some blowback to Russia’s trading partners. No wonder the Chinese authorities have chosen not to participate in these sanctions.

Central banks have the unenviable task of setting interest rate policy at a time of heighten uncertainty. The task is made infinitely more difficult because the ‘fog of war’ offers no visibility.  As Chairman Powell stated in his most recent testimony before Congress, yesterday:

“The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain, “.   Yet the Chairman made it abundantly clear that the Federal Reserve is poised to start raising rates by mid-March.

The Bank of Canada seems to be the first out of the gate with its announcement that it increased its policy rate from ¼% to ½% this morning, despite acknowledging that the “the invasion of Ukraine by Russia is a new source of uncertainty”. What makes the BoC decision questionable is the Bank’s acknowledgement that, “Prices for oil and other commodities have risen sharply. This will add to inflation around the world, and negative impacts on confidence and new supply disruptions could weigh on global growth. (Statement March 2)

Alone, this BoC rate hike will not have any significant impact on the economy since the yield curve has already anticipated rate hikes. However, a steady stream of rate hikes is an entirely different matter. Energy and agricultural output are very inelastic in the short term, raising the question of how will interest rates hikes stem the tide of commodity inflation related to temporary shortages, exacerbated by military conflict? Chairman Powell freely admitted that the Fed has no policy tool to influence inflation emanating from supply constraints. Yet, he is also prepared to raise rates.  Those taking the longer view will point out that a steady drumbeat of rate hikes will slow growth dramatically and force the central banks to reverse gears and lower rates in effort to revive growth.