Central Banks Rush to Quell Inflation Crisis They Helped Create

Christopher Anstey
Wed, July 13, 2022 a




(Bloomberg) -- Central banks across the globe are speeding up interest-rate hikes, seeking to crush an inflation surge partly of their own making.

Wednesday saw Canada’s central bank hike a greater-than-expected full percentage point following two half-point moves, South Korea raise by a half point after several quarter-point moves, and New Zealand increase by a half point for a third straight meeting.

In the US, another searing inflation report led to bets that the Federal Reserve would hike by a full point later this month following a 75 basis-point move in June. Investors say the Bank of England may deliver a 50 basis-point shift at its next meeting, double the previous pace, after the UK economy proved surprisingly robust in May.

Lulled by two decades of subdued consumer prices, central bankers by their own admission assumed that cost pressures emerging in 2021 would soon dissipate. But supply-chain snarls proved more lasting -- and now the surge in energy and commodity prices after Russia’s invasion of Ukraine has decisively removed any case for gradualism in combating inflation.

It’s a pace that none of the central banks had penciled in just a few months ago, and it will likely deliver a growth shock that increases the risk of recessions. Fed Chair Jerome Powell made clear last month that failing to get inflation under control would be a bigger mistake than overdoing the monetary tightening, in a sentiment echoed by his UK and euro-region counterparts.

“Central banks will be minded to look through evidence of slowing growth until they are confident the inflation genie is being forced back into the bottle,” Rabobank rates strategists Richard McGuire and Lyn Graham-Taylor wrote in a note Wednesday. “We continue to believe that policy makers are willing to countenance triggering a recession if that is the extent to which they need to shift the demand curve in order to meet this aim.”

In a world where many central banks are picking up the pace, those that lag behind are getting punished by weaker exchange rates -- a dynamic that only worsens inflation, by making imports costlier.

The European Central Bank has yet to start boosting its benchmark rate, and the euro on Wednesday slid below 1 per dollar for the first time since 2002. That was in the wake of a report showing US inflation jumped to 9.1% in June -- spurring bets that the Fed will hike by at least 75 basis points at its July 26-27 meeting.

The euro then rebounded after an ECB spokesperson said the central bank is attentive to the impact of the exchange rate on inflation -- an illustration of the competitive pressures that some have termed reverse currency wars.

Refusing to go along with the trend is the Bank of Japan, with Governor Haruhiko Kuroda dismissing a pickup in inflation in his country as being mainly driven by commodities -- not the kind of stable price increases he’s been seeking.

What Bloomberg Economics Says...

“In the end, monetary policy makers will get prices under control. That won’t happen soon enough to save households from a major blow to their budgets, or central banks from a major blow to their credibility.”

--Tom Orlik, chief economist

The yen has reflected the BOJ’s gap with its peers, sinking 16% against the dollar so far this year -- stoking concern in the Kishida administration, if not so much in the halls of the BOJ.

In the US, Powell and his colleagues have continually had to rip up their plans for what started out late last year as a “normalization” in policy after pandemic-era stimulus but is now the most aggressive tightening campaign in decades.

Getting its call on inflation being “transitory” quite wrong, the Fed late last year brought forward the end of quantitative easing.

It began hiking rates earlier than it had once anticipated, then in May doubled the pace of tightening to 50 basis points. By last month, policy makers concluded they needed to move even faster, with the first 75-point increase since 1994.

Entrenched Concern

Traders are now pricing in roughly a 50-50 chance of a 100 basis-point hike this month. Tiff Macklem, the Bank of Canada governor, delivered an increase of exactly that magnitude on Wednesday.

“This decision does reflect concern” about inflation becoming entrenched, Macklem said at a press briefing.

The hope is that faster rate hikes now can ensure that high inflation doesn’t become embedded for the long haul. Gauges of long-term inflation expectations in the bond market suggest that investors expect central bankers will achieve that task.

So-called breakeven rates suggest 10-year inflation expectations around 2.35% in the US, with Germany at 2.08% and Canada at 1.98%. The UK 10-year breakeven rate is 3.68%.

But the cost may be economic downturns, sooner than previously thought.

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