The governing council of the European Central Bank (ECB) meets this Thursday, with geopolitical risk having significantly increased since its last meeting. The uncertainties caused by the war in Ukraine have been added to by the situation in Gaza and the risk that this could spread more widely in the Middle East.
In the US, the Federal Reserve Board has warned of the dangers of “broad adverse spillovers to financial markets” in its latest Financial Stability Report. Markets are already nervous, watching higher oil prices and concerned about the impact on growth.
The economic and financial implications are, of course, very much secondary to the enormous humanitarian and political considerations. But there is no doubt that the conflict in Gaza and the regional risks are adding significantly to an already uncertain economic outlook.
Central to this is the dilemma of growth slowing, while inflation - for now anyway - remains above the target level set by central banks. The risks of " higher for longer” official interest rates has set the borrowing cost on government bonds significantly higher, particularly in the US. In the UK, meanwhile, the Bank of England is clearly signalling that interest rates will stay high for quite some time.
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The interest rate dilemma faced by the ECB is underlined by all this. The central bank has persisted with increasing interest rates, even though this causes risks to economic growth, which is already clearly slowing. Now geopolitical factors risk both slowing growth and possibly increasing inflation, most likely through the channel of rising energy prices. Oil prices are not as significant a factor in economies as they were in previous energy crises in the late 1970s and early 1980s, but they are still important.
The ECB council is not expected to change interest rates at this week’s meeting, being held in Greece. And it would surely be wise to sit on its hands and see what happens. Its subsequent meeting, in mid-December, will be more interesting. Both what it does and the messages it sends will be important.
The geopolitical impact on economies also has implications for budgetary policies. Uncertainty and risk puts pressure on those with less resilient positions. Ireland is fortunate in this respect, with successive budgets in recent years moving the Government finances into surplus and money being set aside into special funds.
There have been successive calls to spend more, but the benefit of a more prudent approach is now evident. Ireland still has a large national debt, but it is also planning for significant surpluses and has resources set aside It thus has room for manoeuvre. As central banks withdraw supports for State borrowing, this is a wise strategy which needs to continue,