Rising energy prices stemming from Russia's invasion of Ukraine will make already soaring inflation climb higher. Nevertheless, the Federal Reserve is unlikely to pursue an aggressive rate hike push to clamp down on rising prices that was a near-certainty to market observers less than three weeks ago.

Since Russia launched military operations in neighboring Ukraine on Feb. 24, the odds of the rate-setting Federal Open Market Committee approving a "supersized" rate hike of 50 basis points at its next meeting March 15-16 have tumbled below 5%, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market. That is down from over 90% on Feb. 10 after the U.S. Bureau of Labor Statistics reported that the consumer price index, the market's preferred inflation metric, climbed 7.5% year over year in January, the fastest rate of annual growth since 1982.

"The biggest risk to the economy is not what's happening in Ukraine, it's the likelihood of a [monetary] policy mistake," said David Sadkin, president at Bel Air Investment Advisors.

The personal consumption expenditures index, the Fed's preferred inflation metric, rose 6.1% year over year in January, the U.S. Bureau of Economic Analysis reported Feb. 25, also the fastest growth in 40 years and well above the Fed's goal of 2% annual inflation growth.

The Fed typically raises interest rates in the face of rising inflation. Going too high and too fast, however, threatens to curb economic growth and push the central bank off its course of gradually pushing rates higher to tackle longer-term price jumps.

$100 oil

The conflict in Ukraine pushed Brent crude oil prices above $100 per barrel for the first time since 2014, likely causing inflation to soar further.

"Higher energy prices will now add to the headline inflation outlook," Kathy Bostjancic, chief U.S. financial economist with Oxford Economics, wrote in a Feb. 25 note.

High prices for oil and other forms of energy will likely keep the personal consumption expenditures index growing above 3% into at least late 2022, a level the Fed will consider "unacceptably high," Bostjancic said.

The FOMC, which has not approved a rate hike of 50 basis points since 2000, is still expected to approve a more traditional rate hike of 25 basis points at its March meeting. A larger hike is "dead in the water," even with inflation soaring, said Jeff Schulze, an investment strategist at ClearBridge Investments.

"The Fed sees no need to jump the gun," said Schulze. "They really don't want to create a policy mistake with all the uncertainty that's floating around out there."

2022 rate hikes

While the Fed's concerns about rising inflation grow, it can remain somewhat more cautious going forward as its mandate on employment has been largely fulfilled, Schulze said. The U.S. labor market remains tight with unemployment falling to near pre-pandemic levels.

Most analysts expect a rate hike of 25 basis points at most, if not all, of the seven remaining FOMC meetings in 2022. The Russian offensive in Ukraine is unlikely to deter this view.

"The macro in the US is simply too strong and the negative impact from the Ukraine war too little, to change the Fed's normalization path," said Carsten Brzeski, global head of macro at ING.

In addition, rising energy prices may serve as somewhat of a buffer to soaring inflation as the costs of gasoline and heating oil, for example, cut into other spending, causing growth to slow, said Sadkin with Bel Air.

"We may start to see the economy begin to slow down on its own and the need for the Fed to go on this very aggressive rate-hiking path may dissipate," Sadkin said.