The war in Israel has put the Fed and the ECB in trouble. Now anything can happen

The Israel-Hamas war is the unexpected event that can really get the central banks, primarily the Fed and the ECB, into trouble.
After months of trying to catch up on inflation, central bankers began to believe they had finally set interest rates at the right level to keep prices under control without completely suffocating the economy.
The complex situation in the Middle East is instead introducing a new series of real risks.
Powell said it clearly in his most recent speech: the escalation of geopolitical tensions represents a threat to the global financial system in a context of greater risks of higher inflation and slower growth.
With gas and oil prices already on the move, with new surges, inflation may heat up in ways not expected.
Thus forcing the Fed and ECB to further increase rates and making a recession more likely.
The war in the Middle East could really get the ECB and Fed into trouble and make all their policies fail.
read also Has the ECB finished raising rates? What to expect All the troubles for the Fed and the ECB with the war in Israel The ECB meeting on 26 October and the Fed meeting on 1 November are eagerly awaited as they haven't been for some time.
A pause in rate increases is expected by most analysts, but the war in Israel with such unpredictable and dramatic outcomes can really upset every plan.
Anything can happen in the next meetings.
The US and Eurozone central banks see the possibility of taming inflation without triggering a real recession by keeping rates at current levels for months: a "higher for longer" move which now convinces the markets to postpone bets on first rate cuts in mid-2024 and beyond.
This calculation, so far, has not been shaken by the 10% rise in oil futures to around $94 following the October 7 Hamas attack on Israel – a gain that adds a tenth of a percentage point to the “headline” measure of underlying inflation, the one observed precisely by central banks.
In the worst-case scenario, the price of oil could even reach $150 a barrel: “You have to make some sort of assessment of…
an oil price of $150 a barrel,” the Bank of England's chief economist said Huw Pill at an event this week.
This could happen if Hamas ally Iran reacts by cutting off energy flows from its OPEC neighbors through the Strait of Hormuz.
Europe is exposed because, unlike the United States, it does not have substantial domestic oil production.
Rising gas prices would also fuel inflation, even though, at least for now, the country has a lot of gas in storage.
read also How important is the war in Israel for the price of gas in Europe? Yannis Stournaras, governor of Greece's central bank, argued that Europe had largely managed to absorb the effects of rising energy costs triggered by the war in Ukraine and hoped it could do the same if further shocks occurred.
“It will depend on the duration, it will depend on whether it will be extensive or whether it will be local,” he told Reuters, adding that conflicts typically increase inflation by weakening overall economic activity.
Further unknowns include how uncertainty affects consumer and investor morale and what effects it may have on the mindsets of companies and workers when setting wages in the future.
All factors well observed by the ECB and the Fed.
In the event of a worsening of sentiment, the monetary policy pursued so far could suffer shocks and prove once again inefficient.
Lagarde and Powell could find themselves in the awkward position of still having to raise rates, perhaps at their end-of-year meeting.
At this point, any doubts about growth could translate into a recession.
read also Oil price towards $100 a barrel? All the factors to monitor Geopolitical risk scares central banks Geopolitics is now the specter that scares markets, investors and central bankers.
In a world in motion, between wars, conflicts, commercial tensions, reorganization of partnership relationships, rivalry between powers is growing in every area.
And the danger is that a balance and a drive for cooperation will no longer be there.
In its latest semi-annual financial stability report, the US central bank warned of the risk of "large negative repercussions on global markets" if the conflict in the Middle East and the war in Ukraine intensified or tensions emerged elsewhere.
“The escalation of these conflicts or a worsening of other geopolitical tensions could reduce economic activity and increase inflation around the world, particularly in the event of prolonged disruptions to supply chains and production disruptions.
The global financial system could be affected by a retreat from risk-taking, declines in asset prices, and losses for exposed businesses and investors, including those in the United States,” the report said.
The forecast is grim.
The speed and scale of the recent rise in interest rates has fueled fears of possible financial instability, with a senior International Monetary Fund official recently telling the Financial Times that there is now an "increased risk" of some kind of relapse.
Should inflation unexpectedly persist, prompting central banks to have to raise rates further, the Fed warned not only of greater market volatility but also of a “significant economic slowdown” as credit it dries up and vulnerable families and businesses are forced to scale back their spending.
Last week Jamie Dimon, CEO of JPMorgan Chase, warned that the current moment could be “the most dangerous moment the world has seen in decades.”

Author: Hermes A.I.

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