With central banks’ work halfway done, inflation debate changes course

The inflation has slowed sharply across much of the world this year, but the job is only half done, even as major central banks they are now preparing to conclude their most aggressive interest rate hike cycle in history.

The “last mile” to eradicate widespread price growth will still take years, so loosening monetary policy now seems contradictory to the message from central bankers a year ago that public confidence demanded a return to get inflation on target quickly, even if it meant inducing a recession.

Yet as central bankers from around the world gather in a mountain retreat in jackson holeWyoming, to share ideas on the economy, there is talk of keeping rates around where they are now – but for longer than perhaps previously estimated – rather than raising them higher.

The aim would be to ensure a soft landing for the economy even if price growth remains strong, possibly through 2024.

At first glance, the change seems justified, given the surprising advances in inflation. Price growth was hovering around 10% in much of the developed world at the end of last year and now stands at around half that rate, with further declines already expected.

But this happens while the working market it remains exceptionally tight on both sides of the Atlantic, an economic paradox that leads some to wonder if inflation is receding despite monetary policy, not because of it.

The labor market was expected to ease, reducing pressure on wages, but companies are not laying off workers as expected, partly because they enjoy still-high margins and can afford to retain skilled labor for now.

“When inflation falls but unemployment remains stable or decreases, the Federal Reserve you can’t be sure your policies are effectivesaid Steve Englander, head of G10 currency research at Standard Chartered. “You may just be lucky that a drop in global demand or internal forces unrelated to monetary policy are driving inflation down.”

No job lost yet

Unemployment in USA it has held steady at around 3.5% for most of this year, and the euro zone rate is at an all-time low of 6.4%. Meanwhile, in places like Great Britain, Australia or New Zealand, the rate is slightly above recent lows, but still well below historical averages.

The problem is that serious disinflation without a labor market shock is inconsistent with standard economics and past experience. The us inflation, for example, has fallen 6 percentage points in the last year, from more than 9% to around 3%; The last time inflation fell so low – in the early 1980s – unemployment shot up above 10%.

This disconnect led the German central bank to warn its peers this week that monetary authorities still have a tough job ahead of them.

“The impression has set in that, despite everything, inflation rates will persist for longer above the rates set as a target by central banks,” said the Bundesbank. “In particular, the current high wage pressures could make it difficult to curb inflation.”

However, there is not much appetite left to raise rates much higher, a sentiment that will only increase if measures of economic health deteriorate, as they have in Europe.

The Bank of England still has a ways to go, but the Federal Reserve and the ECB they seem to be debating whether a single more rise is necessary. The Reserve Bank of Australia and the Reserve Bank of New Zealand, for their part, could be done by now.

This raises some questions about the resolve of policy makers, as inflation will remain above target until 2024 and possibly 2025, the end of the current forecast horizon for many.

“Markets do not trust the ECB to reach the 2% inflation target…the markets are assessing that the ECB accepts an inflation overrun”, said Piet Haines Christiansen of Danske Bank.

In fact, long-term inflation expectations for USA and the euro zone remain above the banks’ 2% targets. . But if there is no desire to raise rates much more, which could lead to a recession and a shock to the job market, rates will have to stay high for longer.

Philip Lane, the ECB’s chief economist, may have recently anticipated this approach by saying that the objective is not to curb demand, but to limit its growth.

“The trick for us is basically to make sure that demand doesn’t add to supply,” Lane said on a podcast. “So this is not about making the lawsuit deeply negative. It just has to grow slower than supply.”

Concern for China

The biggest source of uncertainty likely to keep central bankers up at night is the rapidly fading outlook for China, a fact almost as startling as the painless drop in inflation in the developed world and likely the topic of debate this week in Jackson Hole.

The chinese economywhich was expected to prop up global growth in a post-pandemic rebound, is now suffering on all fronts and the People’s Bank of China has already cut rates to stimulate growth.

“Externally, China suffers from the decline in foreign trade. Domestically, its real estate sector remains in jeopardy, the yuan suffers bouts of deflation, and it is increasingly unable to generate enough jobs for its graduates.” said Niels Graham of the Atlantic Council.

The government has unveiled a series of stimulus measures of late, from boosting consumption of cars and appliances to easing some property restrictions and promising support for the private sector, but economists say much more will be needed. .

Much of China’s problems stem from a real estate that has been showing signs of tension for two years. The main reason for concern is that any major bankruptcy in the sector could increase the risk of contagion to the financial market and spread more widely.

But even in the best of cases, weaker growth will reduce demand for imports and complicate the global outlook.

“The lack of a stronger stimulus response reflects in part a greater tolerance for economic weakness”said Julian Evans-Pritchard of Capital Economic. “But it also points to a worrying degree of political paralysis, suggesting that the slowdown could persist for a while longer.”