Central banks face tough decisions after Russia’s invasion
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Trader working, Federal Reserve Chair Jerome Powell can be seen delivering remarks via a screen on the New York Stock Exchange (NYSE) floor on January 26, 2022.
Brendan McDermid | Reuters
LONDON – Just as many central banks had set their sights on normalizing monetary policy as economies emerged from the coronavirus pandemic, Russia’s invasion of Ukraine threw them another curveball.
The U.S. Federal ReserveIt was approved last week first interest rate hike in more than three yearsAs it seeks to control inflation, the committee has already penciled in additional increases for each of six policy meetings in 2018.
The Bank of EnglandIt was imposed third consecutive rate hike but struck a relatively dovish toneInflation will remain higher due to the Russia-Ukraine war and its rising pressure on energy prices.
European Central BankLast week, President Christine Lagarde stated that policymakers have “extra space”Between the end of the ECB’s quantitative easing program in the summer and a hike in the cost to borrow money for the first time in over a decade. The ECB announced this earlier in the month surprised marketsIt announced that it will end its asset purchasing program during the third quarter 2022.
The Bank of England was slightly surprised to see the Bank of England react differently after its more hawkish start, however, both the Fed & the ECB were pleasantly surprised by the hawkish side. This demonstrates the balancing act that policymakers must perform.
Central banks the world over have been caught cold by a surge in inflation in the aftermath of the pandemic, which has sent annual consumer price increases to multi-decade – and in some cases, record – highs.
To ‘walk in the footsteps’
The risk, economists have suggested, is that by tightening policy aggressively even as growth is threatened by the conflict and financial conditions and the labor market tighten, central banks could inadvertently trigger “stagflation” — a period of high inflation, low growth and high unemployment.
However, the vast majority of those surveyed seem to favor reining in inflation and not worrying about economic growth. They have not been deterred by potential war impacts.
Hugh Gimber of JPMorgan Asset Management was the global market strategist for JPMorgan Asset Management. He stated that policymakers felt “uncomfortably behind” the curve at the most recent round of central banks meetings and were eager to normalize policies.
Even though policymakers may have spoken tough about tightening, in fact monetary policy is still supportive of growth, despite recent rate hikes. Gimber indicated that while they might be selling tightening but are yet to actually walk the walk, Gimber added.
Gimber pointed out that patience is a key theme of policymakers’ messages last year. This means any policy mistake was most likely due to them moving too slow rather than too fast.
Yet, a year later, inflation has reached multi-decade levels and the labor market is showing remarkable signs of recovery. ‘Patience’ has been abandoned – ‘optionality’ is the new buzzword,” he said.
“Further policy tightening is ahead. The central banks desire the possibility to move faster if inflationary tensions don’t show any signs of easing.
“Divisions of labor”
Mario Centeno (Portuguese central bank governor, member of the ECB Governing Council) stated last week to CNBC that conditions had not been met for a rate rise-off. Normalization was still “neutral” as well as “data-dependent.”
Centeno indicated that the outlook of the euro zone is affected by the length of conflict and Western sanctions against Russia.
“Unemployment is perhaps the most reliable indicator of European economic health these days.” We have a very strong labor market coming out of the recession — it was usually supported by fiscal policy measures, that’s why I think that’s why coordination is a very important issue in Europe,” Centeno said, suggesting that governments and central banks need to remain in lockstep.
He said, “Even though it isn’t likely to be the most probable scenario right now, a scenario of low growth and high inflation is possible in the future. We must be careful.”
The tug-of-war between supporting growth and controlling inflation seems to favour the former. Brunello Rosa, CEO & head of research at Rosa & Roubini, agreed with this approach and the “division of labor” required between monetary and fiscal policy, telling CNBC that inflation is a more immediate threat.
According to him, “If you reduce a tenth of a percent or even all of a point of growth due to the potential effects of war and sanctions, then you’ll still be able have an optically acceptable growth rate,” he said last week to CNBC.
Inflation reaching 8% in USA, 6% Europe, and 7% in UK is unacceptable. And what are the risks? If inflation is too high, it can become ingrained and you end up in a wage spiral nobody wants. Were we getting closer? We are.
History is full of lessons that can be ‘troubling’
Capital Economics chief economist Neil Shearing shared this opinion in a research paper on Monday. But, Fed officials’ more aggressive projections of interest rates have caused concern that the economy might be headed for recession.
Shearing explained that this raises the question “Are major developed economies strong enough for monetary tightening?”
He added that the lessons from history – notably the eight tightening cycles since the late 1970s in the U.S., five in the U.K. and three in the euro area – are “troubling.”
“This makes 16 tightening cycles in total – 13 of which have ended in recession. “Soft landings are difficult to achieve,” he said.
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