Dr. Kieran McQuinn:

It is very difficult to quantify. Obviously, a lot will depend on the response of the European Central Bank and the monetary authorities there. Indeed, the whole issue of future interest rates will be very interesting because, typically in the case of a very sharp pick-up in inflation such as we are witnessing now and are likely to witness going forward, the standard response of the ECB and other agencies would be to increase interest rates as a way of controlling inflation. To date, the ECB has been reluctant to do so in the context of the inflation increases we have seen prior to the Ukrainian issue. That has mainly been because, as I stated in response to an earlier question, many of the European institutions are cognisant of some of the mistakes that were possibly made during the financial crisis when, for instance, there was a tightening by the ECB of monetary policy in 2008 and 2012. In hindsight, people regard that as a profound mistake. The danger is that if one starts to tighten monetary policy at the wrong time, it will choke the recovery of economies from the pandemic. Of course, now economies will also be hit by this significant shock from the Ukrainian situation and that will counterbalance to a certain extent what the ECB decides to do in response to inflation. It is a very difficult position for the ECB to be in. It will witness substantial increases in inflation but it will also be mindful of the effect the crisis is having on everyday economic activity and it is going to try to sustain that economic activity through this crisis in the way it did during the pandemic.

In terms of the way the ECB has been dealing with it to date and in the context of the kind of asset purchasing schemes it has in place, the way in which it signalled it was going to deal with the inflationary issue was to wind down those asset purchase schemes initially and maybe accelerate the winding down of those schemes before it would start to increase the policy rate itself. Of course, it is possible it will not wind down those asset purchase schemes if, for instance, it sees that countries are getting into difficulty in terms of sustaining the fiscal costs that may come about as a result of the crisis. It is a sticky wicket for the ECB in terms of how it deals with and reacts to the present situation. Clearly, its response will be crucial in terms of the scale of the impact of a Russian economy default and its impact on interest rates within the euro area.