By Howard Schneider, Balazs Koranyi and Mark John
WASHINGTON, Dec 7 (Reuters) – Richmond Federal Reserve Chairman Thomas Barkin was poring over the latest inflation-related data after breakfast with bank interns one morning in June when he saw an alarming sign. Prices had risen in May after falling slightly in April, raising hopes that any fresh rise in inflation would be short-lived.
Barkin said the data, which sparked a sell-off in the U.S. bond market, prompted him in a phone call with Federal Reserve Chair Jerome Powell to voice his support for a larger rate hike than the one the Fed was so comfortable with days later as promised. “Move as fast as you can without damaging things,” Barkin said in an interview last month in his message to Powell.
It was one of many conversations Powell had with Fed rate-setters in the wake of the data, according to his public calendar for this Friday and Monday, as the world’s most powerful central banker sought to end months-long parrying over whether to take tougher ones Measures to contain inflation.
Within days, the Fed announced a larger-than-expected 75 basis-point hike, the largest single hike in almost 30 years and part of the steepest rate hike since the 1980s. It was the cue for central banks around the world to join in a reversal of decades of easy money policies that will impact the economic wealth of people around the world.
Central bankers, who just a decade ago were hailed for their role in bailing out the economy from the global financial crisis, now have their credibility at stake as they deal with inflation that has not been seen in decades.
From Washington to Frankfurt to Wellington, their mantra is that more rate hikes are needed, even if – as Powell has publicly stated – it means “some pain”. Higher borrowing costs weigh on homeowners and squeeze business margins.
And her job is expected to get tougher next year. The challenge: agreeing how fast and how much further to go if economic problems worsen. Powell has already been criticized by both sides of the US Congress; Monetary policy in Europe has been questioned by politicians including French President Emmanuel Macron, who has urged central banks to be “very cautious”.
The story goes on
Powell, who declined to be interviewed for this story, has repeatedly stated publicly that while he seeks to avoid the mistake central bankers made in the 1970s of acting too slowly, he also understands the credibility risk of surprise financial markets.
Ahead of the price data released in June, Fed officials had expressed differing views on how temporary the rise in inflation would be and what action was needed. The new numbers showed how ingrained it was and that the small hikes made up until then weren’t working.
Powell explained the rate hike in June, afterward telling reporters that only once or twice in his decade-long Fed career has such landmark data come so close to a rate decision. To those who say he is too slow to act, he has admitted on several occasions “after the fact” that he would have acted sooner.
EARLY WARNING SIGNS
After years of tame inflation, Fed officials and other central bankers say they have faced a chain of disruptive events beyond their control, ranging from the COVID-19 pandemic to the war in Ukraine.
There was little precedent for how quickly things moved from an era of sluggish price growth to a point “where policymakers had to make a real effort to bring inflation down,” said Agustin Carstens, head of in Switzerland resident Bank for International Settlements, known as the Central Bank for Central Banks.
In the United States, there have been signs over the past year that inflation is soaring to new heights, from labor shortages to shortages in supplies of a growing range of goods and services.
Barkin of the Richmond Fed told Reuters he had returned from a visit to Charleston, South Carolina in June 2021, puzzled by anecdotal evidence that many people were not returning to work. Parents, he said, are having trouble finding day care.
David Altig, research director at the Atlanta Federal Reserve, said the consensus view at the time that supply shortages of goods and services would gradually ease was not reflected in data and anecdotal evidence.
“It just didn’t happen,” Altig said.
The Federal Reserve stuck to the view that the surge in inflation would taper off as the pandemic-ravaged economy returns to normal. “We continue to expect inflation to fall over the course of the year,” Powell said in January, as the Federal Reserve kept interest rates near zero.
The central bank began raising interest rates in March, but officials remained at odds over how much it would need to raise until consumer price data released in June ended the debate.
ORGANIZE HAWKS
The Fed’s move to a more aggressive stance, without scaring markets, helped secure a majority for tougher action at the Frankfurt-based European Central Bank (ECB).
By early summer, a group of political “hawks” was urging the ECB to commit to more than a token 25 basis-point rate hike and align with the Fed, according to more than a dozen officials with direct knowledge of the ECB Discussions.
Fears that the interest rate hikes could lead to an explosion in the borrowing costs of indebted euro countries – especially Italy – led to an agreement in June to help these countries with a so-called “Transmission Protection Instrument” (TPI) if necessary in order to activate their debt support.
“There was a common consensus that by addressing tail risks, TPI would also make it smoother to conduct a tightening cycle,” ECB chief economist Philip Lane — one of the “doves” opposed to swift tightening — told Reuters.
At an ECB meeting in July, hawks — led by ECB board member Isabel Schnabel of Germany, Dutch central bank governor Klaas Knot and German Bundesbank chief Joachim Nagel — were pushing for a bigger move than the 0.25% move, according to talks the markets have been signaled the same by more than a dozen officials.
Those officials said the group, which coordinated by phone and in-person meetings, tried to persuade Lane that she now had a majority on the ECB’s rate-setting Governing Council for such a decision. The ECB announced a 0.5% rate hike in July, followed by a 0.75% hike in September – the biggest move since 1999. In lockstep with the Fed, another hike followed on November 2nd by 75 basis points.
In response to a request for comment from Schnabel, an ECB spokesman said policy decisions are taken at Governing Council meetings after evaluating all incoming information and after a thorough exchange of views.
Knot and Nagel declined to comment.
Impending showdown?
Although some economists say an inflation peak may now be in sight, central bankers are far from taming inflation. In the United States, it is more than three times the Fed’s target of 2%, which is the central bank’s preferred measure.
Powell said last week the Fed would “slow down” the pace of rate hikes. Financial markets are now expecting a 0.50% hike at the next Fed meeting in mid-December – the same hike the ECB is expected to announce a day later.
But both Powell and ECB colleague Christine Lagarde have insisted that rate hikes will continue. The concern of some central bankers is that politicians will respond by increasing public spending, adding to the inflationary pressures that their rate-hike program is designed to cure.
Last week, Lagarde warned that such spending could push up demand and pull it even further away from supply, “forcing monetary policy to tighten more than otherwise necessary,” pointing to signs that this is already happening in the euro area happens.
Former Bank of England official Charles Goodhart believes record levels of public debt could eventually pose such a risk to financial stability that central banks may have to abandon their monetary tightening efforts midway.
If that were to happen, central bankers would have to “reverse course to prevent the debt market from becoming even more disordered,” Goodhart told Reuters.
The BIS’s Carstens said he was certain central banks would stand firm in the fight against inflation. But the past two years have shown the importance of overall economic policy coordination and that the old notion of central bankers as “policy responders of first resort” is outdated.
“Going forward, that probably won’t necessarily be the case — at least not to the extent that we’ve seen over the last several decades.”
(Reporting by Howard Schneider in Washington, Balazs Koranyi in Frankfurt and Mark John in London; Additional reporting by Lindsay Dunsmuir, Leika Kihara and Francesco Canepa. Editing by Cassell Bryan-Low)
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