Putin's war has destabilized the world economy and inflation may be just the start

As images from the conflict in Ukraine attest, war can completely change the rules of economics.

Suddenly people who only a month ago were worried about keeping their jobs and paying their mortgages are on the move, some to the Polish border to escape shattered homes, some to risk their lives in battle.

By definition it is the unexpected that perturbs the world economy and the markets that are one of its real-time barometers.

As Canadian inflation hits new highs and the world's most powerful central bank makes its first attempt to restrain an explosion of rising prices, even a continent away, Russia's invasion of Ukraine has triggered an unpredictable alteration in what we thought were the conventions of global economics.

"The human toll is tragic, the financial and economic implications for the global economy and the U.S. economy are highly uncertain," is how Jerome Powell, chair of the U.S. Federal Reserve, began his address Wednesday as he announced the central bank would raise interest rates by one quarter of a percentage point.

That is the same increase announced by Tiff Macklem at the Bank of Canada two weeks ago. Of course Macklem's small rate hike was too late to stop Wednesday's rise in Canadian inflation which hit a 30-year high of 5.7 per cent. 

As Powell said in his speech, most of the recent surge in inflation cannot be blamed on Russian President Vladimir Putin. The exception is gas price hikes caused by the war, which have already aggravated the latest Canadian rise.

But while its full effect has yet to show up in the statistics, Putin's war is already pushing North American consumer prices higher than if the war had never happened.

Asked directly about the impact of sanctions on the U.S. dollar and its place as the default currency for world trade, Powell explicitly refused to address the question other than offering general support for sanctions and to say they were  the remit of politicians. He said central bankers had only been technical advisors.

But Powell made it clear that the Russian invasion of Ukraine, and the world's response, held both actual and potential implications for the U.S. economy and for its monetary policy.

"In addition to the effects from higher global oil and commodity prices, the invasion and related events may restrain economic activity abroad and further disrupt supply chains, which would create spillovers to the U.S. economy through trade and other channels," said Powell.

There are increasing signs that the new European war has been the catalyst for a series of shifts in the global economy, of which even higher than expected inflation is only a single result.

"The volatility in financial markets, particularly if sustained, could also affect credit conditions and affect the real economy," said Powell.

The Federal Reserve chair said that while the central bank had to be aware of those potential challenges, his principle goal remained fighting domestic inflation with a stream of interest rate hikes over this year and next that is expected to take rates to 2.8 per cent by the end of 2023.