2023-12-03 10:27:53
Central bankers are facing accusations of being too slow to respond to signs that the inflation crisis is fading, less than two years following they were criticized for being late in responding to the most brutal price rise in a generation.
Some policymakers are already warning that by waiting too long to lower borrowing costs, central banks might hurt weak economies – where the euro zone has remained stagnant all year – or hobble heavily indebted governments like Italy’s, the Financial Times reported. In her report.
The European Central Bank was at the forefront of this debate this week, following euro zone inflation fell to 2.4 percent, its lowest level since July 2021, bringing price growth surprisingly close to the bank’s 2 percent target. Similar discussions are brewing in the United States and the United Kingdom, even if headline inflation rates there have not yet fallen to that level.
The Financial Times quoted Ennis McVeigh, chief global economist at Oxford Economics, saying: “The question is: Which of the major central banks is at risk of making a monetary policy mistake here? For me, it is more likely to be the ECB, because inflation will come down quickly. “They have every incentive to speak out, but the procedure must change.”
Investors reacted to a third straight month of below-expected euro zone inflation data last week, by placing their bets on when the European Central Bank will start cutting interest rates. Many economists now expect this to happen in the first half of next year.
When does the interest rate cut start?
Dirk Schumacher, a former European Central Bank economist who works at the French bank Natixis, said that inflation in the euro zone is on track to reach 2 percent by next spring. But policymakers’ fear of underestimating inflation once more means “it will take a little longer to reach enough board consensus to cut.”
He expected the European Central Bank to cut interest rates in June, then proceed with a quarter-point cut at each meeting next year.
The new governor of the Italian Central Bank, Fabio Panetta, who came from the European Central Bank last month, hinted last week that it may be necessary to cut interest rates soon, “to avoid unnecessary damage to economic activity and risks to financial stability.”
Sovereign bond markets rose following statements by Bank of France Governor François Villeroy de Galhão, with investors adding to their bets on an interest rate cut by the European Central Bank in the first few months of next year.
He said: “The issue of reducing may arise when the time comes during 2024, but not now: when the treatment is effective, you have to be patient enough with its duration.”
But other monetary policymakers are pushing back. German Central Bank President Joachim Nagel said that the “encouraging” drop in inflation last week was not enough to rule out the possibility that borrowing costs may need to rise. He also warned that “it is too early to even think regarding the possibility of lowering key interest rates.”
This argument received support from the OECD last week, with chief economist Claire Lombardelli saying that the European Central Bank and the Bank of England would not be in a position to ease borrowing costs until 2025, given persistent core inflation caused by wage pressures.
Growing pressures
Central bankers are also well aware that the backdrop of slowing demand, high unemployment rates, and the continued suffering of mortgage holders will lead to increased political pressure to ease interest rates.
This is particularly the case given that the UK is heading towards a potential election year. Hugh Bell, chief economist at the Bank of England, told the Financial Times last month that falling prices might give the false impression that the threat of inflation has passed.
He said the challenge facing policymakers is to ensure there is enough “persistence” in keeping monetary policy tight at a time when there will be “a lot of pressure in the face of weak employment growth and activity and low headline inflation, to declare victory and bring down inflation.”
In the United States, where growth has remained much stronger than in Europe, the Federal Reserve has barely wavered in its position that the cycle of rate hikes may never end, and that those who expect relief in the form of cuts will have to be patient.
“It would be too early to conclude with confidence that we have achieved a sufficiently restrictive stance or to predict when we will ease policy,” Federal Reserve Chairman Jerome Powell said on Friday. He added before the last monetary policy meeting of the year in the middle of this month: “We are ready to tighten policy further if it becomes appropriate to do so.”
This hesitation reflects the Fed’s desire to protect its credibility by avoiding the need to reverse course if price pressures remain stubbornly high, a risk that San Francisco Fed President Mary Daly highlighted to the Financial Times in November. .
Pantheon Economics chief economist Ian Shepherdson said another reason behind the Fed’s “extended tightening” was its concern regarding misjudging the path of inflation once more, following it was widely criticized for failing to anticipate rising prices following the pandemic.
But with economic activity expected to slow, demand for labor to decline and wage growth to moderate, Shepardson said the Fed is now flirting with a different kind of forecasting failure – reducing the pace of inflation’s decline.
He said: “Pressures will mount over the next few months, which is why I am sticking to the interest rate cut in March.” Over the next year, the Federal Reserve is expected to reduce the interest rate from 5.25 to 5.5 percent by 1.5 percentage points, and by another 1.25 percentage points in 2025.
Is victory declared?
However, some policymakers say it is still too early to declare victory in the battle once morest inflation, while in the US, there is a risk that recent rapid growth might keep inflation too high.
The Financial Times quoted William English, former director of the monetary affairs department at the Federal Reserve Bank, as saying that in this scenario, the Federal Reserve will not be deterred from keeping interest rates high even if political stimulus intensifies before the presidential elections next year.
“This is the whole point of having an independent central bank, and they really don’t want to spoil that,” he said.
European Central Bank President Christine Lagarde warned last week that inflation in the euro zone is likely to rise once more in December, with the removal of government subsidies that kept energy prices low.
In the eurozone, much of the debate now hinges on core inflation, which excludes volatile energy and food prices. Economists say record core inflation in the past three months shows it has already fallen to the European Central Bank’s target. But others point to one-off factors driving down inflation – such as falling holiday package prices – and say rapid wage growth will keep them high over the next year.
Jorg Kramer, chief economist at Commerzbank, said: “Public pressure on the European Central Bank will increase, especially from heavily indebted member states.” “However, the European Central Bank must resist pressure,” he added, expecting core inflation in the euro zone to stabilize at regarding 3 percent next year.
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