Issue of the week: painful economic medicine
The US Fed is belatedly planning a series of bumper rate hikes. The risks of an accident are rising
Only last year, many economists were expecting 2022 to usher in a period of strong economic rebound. We’d see a new “Roaring Twenties”, some said, like the decade of consumerism that followed the 1918-21 influenza. Fast forward a few months, said the FT, “and the more commonly cited parallel is the 1970s”, when inflation surged to double-digit rates even as economies around the world stagnated. Now, after the double-shock of Covid-19 and the Ukraine war, “stagflation” is again on the cards, striking “fear into policymakers because there are few monetary tools to address it”. Most analysts and economists don’t anticipate a “decade of economic blight” as bad as the 1970s. But with global inflation forecast at 6% or higher, much depends on the actions of central banks. The stakes, as both the US Fed and the Bank of England met to raise interest rates this week, were high.
The debate has totally shifted “from whether interest rates have to rise, to how much they will go up by”, said Simon French in The Times. This is “the sternest test” of the BoE’s independence since it was granted 25 years ago. “Telling the public that slower economic growth today is a price worth paying for lower inflation tomorrow” won’t win the governor Andrew Bailey many friends. But he needs to stick with it. “Policymakers have got themselves into a terrible mess,” said Jeremy Warner in The Sunday Telegraph. Because of the wider problem of over-indebtedness in the UK economy, “half of corporate Britain would be in trouble, not to mention countless indebted households”, if interest rates returned to pre-financial crisis levels (of around 5%). There’s a sense that the BoE “cannot afford to normalise” rates. Still, compared with the pressure on Fed chairman Jay Powell, Bailey has it easy.
Ahead of the Fed’s meeting, hawkish rhetoric from officials triggered “an intense sell-off in the $23trn US treasury bond market, the backbone of the global financial system”, said the FT. The yield on ten-year Treasuries (which moves inversely to price) hit 3% for the first time in more than three years. That could have profound effects on the US economy, “feeding” into mortgage rates and borrowing costs, whatever Powell does. And Wall Street’s fears have been compounded by the shock news that the US economy shrank by 1.4% in the first quarter. There are real concerns about the credibility of the Fed under Powell, said Mohamed A. El-Erian on Bloomberg – because it has “failed so badly to predict inflation in 2021 and so far in 2022”. The Fed “desperately needs to regain control of the policy narrative if it is to have any chance to land the economy softly”.