High rates ahead

Cen­tral banks may get trig­ger happy in 2018

The Hindu Business Line - - THINK - DANIEL MOSS BLOOMBERG

One big eco­nomic risk next year is that things go right. Wait, what? The dan­ger is that 2017’s syn­chro­nised global ex­pan­sion con­tin­ues into 2018, and that cen­tral banks re­spond im­pru­dently. One dom­i­nant theme as this year draws to a close is how mon­e­tary policy in most of the ma­jor economies has ori­ented in the same di­rec­tion — toward phas­ing out the stim­u­lus that has un­der­pinned as­set prices and much else.

Among the Group of Seven, is any­one se­ri­ously pre­dict­ing an in­crease in stim­u­lus? No. Will mon­e­tary policy re­main easy and ac­com­moda­tive? Mostly, but less so.

The prob­lem would arise if mon­e­tary chief­tains de­cide they have to do more than they in­di­cated they would. In the past week, Deutsche Bank AG nudged up its fore­cast for the Fed­eral Re­serve, tip­ping four in­ter­est-rate in­creases in 2018, rather than the three that the Fed it­self has flagged. Goldman Sachs Group Inc. and JP Morgan Chase & Co. were al­ready there.

Isn’t that a sign of strength and re­silience? Yes, but in­vestors have be­come so spoon-fed on for­ward guid­ance that they lose the abil­ity to some­times think for them­selves. (Wit­ness a lit­tle spat in Canada.) If the Fed gets more ag­gres­sive than it has sig­nalled, and econ­o­mists feel they have to keep up­grad­ing — rather than down­grad­ing — in­vestors may start ques­tion­ing some as­sump­tions.

Let’s look at the US. All the fo­cus on dis­ap­point­ments — with gross do­mes­tic prod­uct clock­ing a bit more than 2 per­cent growth year af­ter year — tend to ob­scure one con­stant: The un­em­ploy­ment rate re­lent­lessly grinds lower. Fed of­fi­cials have pretty con­sis­tently un­der­es­ti­mated how low the un­em­ploy­ment rate would go.

What if the job­less rate heads toward 3.5 per cent next year? Does in­fla­tion then be­gin fir­ing? If it doesn’t, do Fed of­fi­cials hold to their faith that in­fla­tion and wages will likely start be­hav­ing when the job­less rate dips even lower?

Lest we think an in­fla­tion up tick — “break­out” seems a tad dra­matic — would be just a US is­sue, let’s take a look at the world’s other big eco­nomic en­gine. China’s pro­ducer prices be­gan ris­ing late last year and have been one of the great un­told sto­ries in the global re­fla­tion.(The West’s re­fla­tion may very well not have been about Don­ald Trump at all.)

Prior to that, fac­tory prices had de­clined for four years. That lit­tle boom let in Chi­nese PPI was sup­posed to have dis­si­pated quickly. It hasn’t. Prices rose 6.9 per­cent in Oc­to­ber from a year ago, beat­ing con­sen­sus of 6.6 per­cent. Is that flow­ing through into con­sumer prices?

The case is am­bigu­ous; CPI was up 1.9 per cent from a year ear­lier. Still mod­est, but a touch higher than many econ­o­mists had es­ti­mated. This isn’t spec­tac­u­lar stuff. Still, it was dis­missed as a short­term boost that would run out of puff. It hasn’t.

Con­tin­u­ing global growth need not be cat­a­strophic. And higher in­ter­est rates are hardly the num­ber one cause for worry. But it’s worth con­sid­er­ing that in 2018, cen­tral banks may see a case for higher rates that they did not fore­cast back in 2017.

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