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Central banks parse inflation risk as turn from pandemic policy begins By Reuters


© Reuters. FILE PHOTO. This illustration shows the euro, Hong Kong dollar and U.S. Dollar as well as Japanese yen, pounds, Japanese 100 yuan, pound, and Japanese yen. The picture was created January 21, 2016. REUTERS/Jason Lee/Illustration

By Howard Schneider, Balazs Koranyi, Leika Kihara and David Milliken

(Reuters) – Central banks that launched massive emergency support to fight the pandemic last year are now planning a global turn in the other direction, with gaps already emerging in their perceived risk of inflation, the need to respond to it, and the pace of the likely return to normal monetary policy.

Common supply shocks are causing them to be concerned as well as the risks associated with a continuing pandemic.

In a Reuters interview, James Bullard, President of the St. Louis Federal Reserve said that “globally we are still infor a long proces” to reopen and adapt to the post-pandemic environment.

However, the impact of the reopening (and associated inflation) is felt differently by different countries. Officials are trying to understand the post-pandemic world and how they can achieve a common goal of 2% without affecting global growth.

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This Wednesday’s virtual European Central Bank Forum will see the four main central banks of the world gather. While there was a general rush to prevent the worst last year, exit strategies for the bank heads are diverging.

This has led to significant policy disagreements in Europe as well as the United States about how much inflation risk central bank should accept as they attempt to compensate for slow prices over the past decade. It is a huge gamble as to whether or not the world after the pandemic will be the same.

The policy divergence of the major global central banks could have an impact on international markets. It can shift capital flows, exchange rates, and trade patterns. Even though the Fed may have some limits as to how far it will go in normalizing or raising interest rates, major partners like ECB might not be moving in the exact same direction.

Although it is early days in the recovery from the pandemic we are seeing differences.

“The key challenge is to ensure that we do not overreact to transitory supply shocks,” ECB President Christine Lagarde said at her bank’s premier research conference on Tuesday, and policy “must remain focused on steering the economy safely out of the pandemic emergency” rather than squelching any short-term increase in prices.

As the ECB does, the Fed also believes that inflation will ease largely by itself. The risks have become more visible and almost all Fed officials projected last week that inflation would be higher than predicted.

Lagarde was speaking, Fed Chair Jerome Powell addressed Congress. He spoke out about the Fed’s projections of inflation for this year, which is twice its target and could make it even more persistent.

‘Surprised’ by inflation


These are just a few of the many problems that could arise. The pandemic is still in full swing, and although businesses and consumers are adapting to some degree, it continues to affect who comes into work, which goods and services are being produced and moved about the globe.

Although workers are returning to work, the pace of their return is slower than expected. The supply shocks that started with 2020’s coronavirus shutdowns continue to impact. These include fuel shortages and delays at German auto plants, U.S. factories without industrial goods, slowing shipping routes, rising prices, and German car plant waits for computer chips.

Last week, the Fed said that it was close to taking steps to end its emergency bond-buying program launched in March 2020. Half of U.S. policymakers reported at their last meeting saying interest rates could need to rise next year.

With markets anticipating a rate hike in February from the Bank of England and annual price rises of 4.4% in the public’s minds, it is possible that the tipping point has already been reached.

“Talk of a ‘cost of living’ crisis is gaining traction … and the public may be looking at the BoE to lean against inflation risks coming out of the pandemic,” Deutsche Bank (DE:) economist Sanjay Raja wrote in a note to clients on Friday.

Japan’s core consumer price index, on the other hand, did not change in August. It is a sign that Japan’s long-running struggle to keep prices low continues. Although wholesale prices are increasing due to the global commodities inflation, Japan’s growth rate is still low and Bank of Japan policy will likely remain loose.

Any post-pandemic policy change has been downplayed by the ECB.

The legislation authorizing bondbuying under its Pandemic Emergency Purchase Programme is expected to decrease. The bank will likely expand its other programs partly to compensate. Lagarde said that inflation staying below the target of 2% is more dangerous than persistently exceeding it.

Major Central Bank Balance Sheets

Looking back on the last decade it’s a natural concern.

After setting 2% for their inflation target in 2012, all major central banks were unable to achieve it despite a decade with slow growth.

It is time to adopt a different policy position – and let’s hope the rest of the world does the same.