(Yicai) May 12 -- Major economies are generally facing the dual pressures of economic downturn and rising inflation due to the Middle East conflict, but various countries' energy reliance differences have led to a distinct asymmetry in the economic impact brought about by the war.

The Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan all maintained a hawkish stance and refrained from taking action during the Super Central Bank Week from April 27 to May 1. However, obvious internal disagreements showed the dilemma of monetary policy in the context of the conflict.

Due to concerns over the upward risk of inflation, the market expects that the ECB, the Bank of England, and the Bank of Japan may start raising interest rates next month or in July. Against the backdrop of the resilient US economy, stable overall labor market, and prominent upward risk of inflation, the market anticipates that the Fed will keep interest rates unchanged until the end of next year.

With Jerome Powell stepping down as chair of the Fed, new Chair Kevin Warsh will preside over the first Federal Open Market Committee meeting next month, so it is necessary to pay attention to the policy changes from the chair transition.

US Economy Maintains Resilience, Faces Rising Inflationary Pressure

In the Beige Book released by the Fed on April 15, the Middle East war was listed as a major uncertainty. Despite that, economic activities in most parts of the US continued to grow at a slight to moderate pace.

In the first quarter, the US' annualized quarter-on-quarter real gross domestic product growth was 2 percent, lower than the expected 2.3 percent, but significantly higher than the 0.5 percent in the previous quarter, mainly because of increased government spending, a turnaround in exports, and faster growth in business investment.

In addition, the US job market remained stable. About 115,000 new non-farm jobs were created last month, compared with the expected 62,000, while the unemployment rate remained unchanged at 4.3 percent, matching the expected figure.

However, the rising inflation pressure caused by the Middle East war is more prominent. The year-on-year growth rate of the US consumer price index increased to 3.3 percent in March from 2.4 percent in February, reaching a new high since May 2024.

Because of the increase in raw material prices and supply shortages, the average selling price of goods and services in the US rose in April to the highest level since July 2022, with the growth rate of raw material prices reaching an 11-month high, according to data from the S&P Global Purchasing Managers' Index.

Intensifying Risks of Economic Downturn and Rising Inflation in Eurozone

The GDP of the Eurozone grew by 0.1 percent last quarter from the previous quarter, lower than the 0.2 percent increase in the fourth quarter of last year. According to the S&P Global PMI data, the Eurozone economy initially entered a stagflationary state in the second quarter.

The Eurozone's composite PMI dropped to 48.8 last month from 50.7 in March, a 17-month low. The service sector was the most severely impacted, with the PMI business activity index dropping to 47.6 from 50.2, the lowest in 62 months.

In the nearly one year before the outbreak of the war in the Middle East, the year-on-year growth rate of the Eurozone's CPI remained basically stable around the 2 percent inflation target. Driven by the increase in energy prices, the CPI inflation rose to 3 percent in April from 2.6 percent in March and 1.9 percent in February, a new high since October 2023.

UK's Economic Growth May Slow Down, Inflation Continues to Rise

As the United Kingdom's economy unexpectedly grew by 0.5 percent in February, the Bank of England predicted the GDP growth rate in the first quarter would reach 0.5 percent, significantly higher than expected, but the second-quarter growth rate would slow to 0.1 percent, slightly lower than the expectation in February, indicating that the impact of the Middle East war on economic growth is relatively mild.

Due to the increase in energy prices, the UK's CPI inflation rate rose to 3.3 percent in March from 3 percent in the previous month, the highest over the past three months. The inflation expectations of British households for the coming year rose to 5.4 percent from 3.3 percent, an increase much greater than that after the outbreak of the Russia-Ukraine conflict in March 2022, according to the results of a survey by Citigroup/YouGov.

Risk of Rising Inflation in Japan Is Greater Than Economic Downturn Risk

The Japanese economy has shown a partial weakening trend after the outbreak of the Middle East war, but has generally recovered moderately. According to the S&P Global PMI data, the Japanese manufacturing PMI rose to 55.1 last month from 51.6 in March, a new high since February 2022. Affected by the service sector, the composite PMI index dropped to 52.2 from 53, but remained above 50 for the 13th consecutive month.

Thanks to the Japanese government's fuel subsidies offsetting the impact of rising energy prices caused by the Middle East war, the country's core CPI inflation was below the 2 percent inflation target for two straight months, growing 1.6 percent in February and 1.8 percent in March.

However, the Bank of Japan noted in its outlook report on April 28 that the increase in oil prices caused by the war in the Middle East will likely exert downward pressure on Japanese corporate profits and household real income and drive up energy and commodities prices due to factors such as the deterioration of terms of trade. Therefore, it has lowered its projected real GDP growth rates for the fiscal years 2026 and 2027 by 0.5 and 0.1 percentage points to 0.5 percent and 0.7 percent, respectively, while raising its core CPI inflation forecast by 0.9 and 0.3 percentage points to 2.8 percent and 2.3 percent.

Interest Rate Hikes by UK, EU, Japan Central Banks May Be Around the Corner

On April 30, the ECB announced that it would keep the three key interest rates at their current levels, the seventh consecutive time it has refrained from making any changes. The impact of the Middle East war on medium-term inflation and economic activities will depend on the intensity and duration of the energy price impact.

The decision was made based on sufficient information, but the governing council not only unanimously agreed to maintain the interest rates, but also conducted a "detailed and comprehensive" discussion on the possibility of raising the rates, Christine Lagarde, president of the ECB, said at a press conference.

The next six weeks will be an important window for assessing the economic situation, allowing the ECB to make a decision based on more complete data at its June meeting, implying that it may initiate its first interest rate hike next month.

There was again a divergence in the interest rate decision of the Bank of England on April 30. The Monetary Policy Committee decided by an overwhelming majority of eight to one to keep the benchmark interest rate at 3.75 percent, with the meeting minutes saying that external members Megan Greene and Catherine Mann and Deputy Governor Dave Ramsden emphasized the risk of rising inflation and might consider supporting an interest rate hike at future meetings.

On April 28, the Bank of Japan announced that it would keep the benchmark interest rate unchanged at 0.75 percent. This was the third straight time it refrained from raising the rate since a hike last December. The interest rate decision was passed by a majority vote of six to three, marking the most significant internal division since 2016.

The uncertainty in the Middle East has led to a decrease in the likelihood of achieving price and economic prospects, so the Bank of Japan needs to spend more time confirming the impact of the war on prices and the economy, Governor Ueda Kazuo said at a press conference. If supply shocks are further transmitted to potential inflation, then raising interest rates will become an essential countermeasure, he added.

Warsh's Fed Will Likely Continue to Adopt a Wait-And-See Approach

On April 29, the Fed released a statement from its FOMC meeting that the situation in the Middle East was contributing to a high degree of uncertainty in the economic outlook. It announced that the target range for the federal funds rate would remain at 3.5 percent to 3.75 percent.

This was the third time that the Fed paused its rate cuts after three consecutive rate cuts in the second half of last year. Four FOMC voting members did not support this resolution statement, which was the largest number of dissenters since 1992.

Apart from the war in the Middle East, the transition of the Fed chair also brings many uncertainties to the future interest rate policies. The first FOMC meeting under the new chair is expected to take place next month.

According to Warsh's testimony at the nomination confirmation hearing of the US Senate Banking Committee on April 21, his monetary policy stance can be summarized as emphasizing the independence of monetary policy, reforming the Fed, and advocating for simultaneous interest rate cuts and balance sheet reduction.

The market has doubts about Warsh's commitment to maintaining monetary policy independence, his plan to reduce the balance sheet, and his ability to cut interest rates, according to a new survey released by CNBC on the Fed. Half of the respondents believe that Warsh will mainly or very independently implement monetary policy, while 46 percent think he will only partially or not independently at all. Some 58 percent believe he is generally inclined towards a dovish stance and is inclined to cut interest rates, up from 44 percent in March.

The Chicago Mercantile Exchange's Fed watch tool showed that as of May 8, the market expected the interest rates to remain unchanged this year and next.

The author of this article is Guan Tao, chief economist of BOC International China.

Editor: Martin Kadiev