There is a school of thought that says central banks have found their mojo again after a decade of fear.
Their concerns stemmed from the 2008 crash, when banks panicked after the US subprime housing crash and the financial system was overflowing with funds. Only central banks could make up the difference – with a lending program known as quantitative easing – and it’s been the same story ever since.
Each time central banks have tried to reinvent the old order by suggesting that interest rates could retreat towards 2% or even back to the old normal of 4% to 5%, investors have been alarmed and forced a reversal. On several occasions, including at the beginning of the pandemic, even more publicly insured money was pumped into financial markets to sustain the bedrock of the capitalist system.
It became almost a joke in the Square Mile that when financial markets faltered, Bank of England officials printed more cash and offered it at near-zero interest rates, hoping it would calm the fevered brows of City traders .
An inflation rate heading for 10% or more has left central banks “no choice” but to show some courage to former Bank of England official Adam Posen and push rates higher, even if it means that this is the case in the midst of the Ukraine war, which triggered a recession.
Central banks used to worry about the collateral damage of higher borrowing costs, not just the impact on investors who have been forced to acknowledge that the value of their stocks depends on central bank support. They worried about small businesses being forced into bankruptcy and mortgage payers being forced to return the keys to their homes. Not anymore, say advocates of a tougher central bank stance.
The first thing to say to those who believe that central banks have regained their confidence is that they differ widely in their response to the current crisis.
In the US, where the government has been bombarding households with cash during the pandemic, most of which has been spent on imports nearly as much as domestic goods and services, the central bank has been licensed by the financial markets to withdraw some of its cheap cash. Now it’s on track to push rates much higher. Meanwhile, Japan is in the opposite corner. The Bank of Japan has promised financial markets to maintain the peace and tranquility enjoyed since the world’s third largest economy collapsed in 1989. To that end, Tokyo will keep borrowing costs below zero for the foreseeable future. In fact, it’s almost impossible to imagine an economic trigger that would cause Tokyo to push interest rates higher.
UK inflation is almost entirely the result of higher energy bills coupled with a rise in food costs as supermarkets have hiked prices to offset margins squeezed by competition over the past decade
Over at the European Central Bank, Frankfurt’s best are grappling with rising inflation, but unlike the Fed, almost all of the pressure is coming from the energy sector and the Ukraine war, not budgets littered with government funds. ECB officials have been making noise about a possible interest rate hike to calm prices, although inflation is expected to fall next year without action, meaning any hike would now likely have to be reversed in 2023.
The Bank of England occupies a peculiar and convoluted position that oscillates from one extreme to the other. For the past six months, a majority on Threadneedle Street’s monetary policy committee has been talking as if the US and UK economies were in the same boat. They argued that too much money was chasing too few goods, wages would shoot up in response to labor shortages, and inflation would potentially shoot up for many years because of this stimulus.
Except that Britain turned out to be more like the EU. Inflation will skyrocket, yes. But there is little pressure from wages because 40 years of draconian labor laws have stripped workers of their bargaining power. Much of the income gains reflected in official stats come from the stellar pay rises being demanded from discrete corners of the job market — from IT pros, corporate lawyers, accountants, and our old friends the City traders.
UK inflation is almost entirely the result of higher fuel and energy bills coupled with a rise in food costs as supermarkets have raised prices to offset margins squeezed by competition over the past decade.
Bank Governor Andrew Bailey, for so long the harbinger of higher interest rates, is now singing a different tune, even after his key rate setters raised interest rates to 1% for the fourth time last week and announced several more rate hikes. Britain is about to enter a “very difficult period” of low growth and high inflation, which could mean higher unemployment, he said.
Fear grips the central bank again. This means interest rates will likely be capped at 1.5% and may not go above 1%. Reductions next year are possible.
Comments are closed.