The mood darkens on inflation
THE central bankers are running scared, and they jolly well should be. The thing that is frightening them is the resurgence of inflation, for they know that if it does not subside soon not only will they have to tighten policy; they will be blamed for not tightening earlier.
Until the last week they could claim that the combination of quantitative easing (QE) and ultralow interest rates had not only supported the world economy through the downturn but also helped engineer a rapid recovery.
The costs had been modest compared with the benefits. There had been quite a bit of asset inflation, including in house prices just about everywhere, but until recently not much current inflation. So they could keep the money taps open.
Now the mood has darkened, as some of us expected it would. In the US they have consumer inflation at 5.4 per cent up on the year. We have consumer prices up 2.5 per cent, but the old retail price index was up 3.9 per cent. The authorities don’t like the RPI and there is an argument that it overmeasures inflation. But it goes back to 1947 and is still used in some wage contracts and indexlinked gilts. Given its long history it is trusted.
Here in the UK, things are starting to move. Two members of the Bank of England’s monetary policy committee, Sir Dave Ramsden and Michael Saunders, both hinted that policy might have to be tightened more swiftly than the markets expected.
Then on Friday, the House of Lords published a report, Quantitative Easing: A Dangerous Addiction? The title says it all – they could have left off the question mark. As Lord Forsyth, chairman of the Lords Economic Affairs Committee, put it: ‘The Bank needs to explain how it will curb inflation if it is more than just short term. It also needs to do more to mitigate widening wealth inequalities that have resulted from rising asset prices caused by QE.’
Lord King and Lord Stern – Mervyn King, former Governor of the Bank of England, and Nicholas Stern, a former Treasury official – were both authors of the report. These are people whose judgment we should trust.
Over in America similar concerns are mounting. Larry Fink, who heads BlackRock, the world’s largest asset manager, told CNBC: ‘I worry about inflation. I do not believe inflation is going to be transitory.’ He is, so-to-speak, backing his words with his wallet. All BlackRock employees will get an 8 per cent pay rise from September.
And the Federal Reserve? The official line is that everything is under control. Jerome Powell, its chairman, told Congress that the surge in inflation was temporary and the prospect of the Fed withdrawing its support was ‘still a ways off’.
Within the Fed, however, there is a debate. Minutes show that some officials feel that policy will have to be tightened soon while others don’t.
We’ll see. What the Fed does matters enormously here because its decisions affect global markets to an extent that no one else, not even the European Central Bank, does.
While it remains relaxed, I would say complacent, that gives cover for other central banks to keep pumping out the cash. Once it signals an end to QE and prepares markets for higher rates, that will push everyone else to do so.
But the Bank of England has some leeway, and I could see a vote to taper down our version of QE quite soon. So what will happen? To be fair to the policy-makers, it is very difficult. We have no experience of anything like this in the past. Central banking is theatre: the chairs and governors have to give the impression they are in charge, even when they know they are not.
It may be that this burst of inflation will peter out and they will be able to tighten policy gradually over the next few years, rather than having to move much faster. It is probably safest to end QE first – stop buying in government debt – then move interest rates up later.
But stopping buying government debt will push the yields up and the prices down. We all know that has to happen, but none of us know when, how fast, and what the consequences for other assets, including equities, will be.
If all that sounds disturbing, consider this. The central bankers are starting to acknowledge what to the rest of us has seemed screamingly obvious. Inflation is a real threat. We should welcome that change of view. It is the first step towards doing something about it.
It is safer to end quantitative easing first – then move rates up later