Aurelia Butler

WASHINGTON (Reuters) -U.S. Federal Reserve officials wrestled Thursday with whether recent data showing inflation, jobs and spending all hotter than expected was a “blip” or a sign that even higher interest rates could be required to slow price rises.The separate comments from Fed Governor Christopher Waller and Atlanta Fed President Raphael Bostic posed a question central to the next phase of the Fed’s battle to lower inflation: Is monetary policy again slipping behind the curve of a surprisingly strong economy that needs even tighter credit conditions, or is slower growth and lower inflation already in train?So far, even hawkish voices like Waller say the jury is out, with jobs and inflation data released between now and the Fed’s upcoming March 21-22 meeting likely key to whether he and perhaps other policymakers tilt towards higher interest rates.”Last month we received a barrage of data that has challenged my view … that the Federal Open Market Committee was making progress in moderating economic activity and reducing inflation,” Waller said in comments Thursday to the Mid-size Bank Coalition of America, an organization of around 100 financial institutions with assets between $10 billion and $100 billion.”It could be that progress has stalled, or it is possible that the numbers released last month were a blip,” he said.If upcoming data shows the economy moderating and inflation slowing, Waller said he would “endorse” the target federal funds rate rising to roughly the same spot policymakers projected as of December, when 13 of 19 officials saw rates coming to rest somewhere from 5.1% to 5.4%. The current policy rate is set in a range between 4.5% and 4.75%. “On the other hand if those data reports continue to come in too hot, the policy target range will have to be raised this year even more to ensure that we do not lose the momentum that was in place,” Waller said. Bostic also said he was ready to raise rates higher if upcoming data did not show inflation “clearly” heading back towards the central bank’s 2% target from its January level of about 5.4%.But he also felt the impact of Fed rate increases so far may only be getting started, a reason to be careful in deciding on further rate hikes lest the central bank overstep. “Slow and steady is going to be the appropriate course of action,” Bostic said in comments to reporters, with perhaps only two more quarter point increases needed before the Fed can pause. Fed rate increases “should bite through the spring … Going at a measured pace reduces the likelihood we overshoot” and damage the economy. More

Greetings from a sunny, serene Brussels. The daffodils are emerging, the birds are singing and there is a deal on the Northern Ireland protocol.European Commission negotiators have emerged blinking from the dreaded “tunnel” of intensive talks required to thrash out an agreement after two years of tensions with the UK. I am told the final days included late-night sessions deciding how much time British businesses would get to tweak production lines to slap labels on produce stating it was “Not for EU”. And precisely which goods could be sold in Northern Ireland below the 5 per cent minimum EU VAT rate. (They settled on only things that could be bolted down such as heat pumps, unlikely to escape across the Irish border.)There was then the difficulty of trying to nail down the Windsor framework, a rather bespoke, ramshackle arrangement, with more than 100 pages of legalese. The agreement ends a bitter dispute over the trading arrangements for Northern Ireland, the result of the UK leaving the EU single market in 2021. To avoid a trade border on the island of Ireland after the UK left the single market one was imposed in the Irish Sea. That led to checks on goods arriving from Britain and a ban on beloved products such as oak saplings, angering Northern Ireland’s unionist community. Here is a quick recap on the main points of the deal that might smooth EU/UK relations, at least for a few months: A new “green lane” for freight destined to remain in the region with lighter controls while freight moving on to — or through — the Republic has tighter ones.The free circulation of British medicines in Northern Ireland.Fresh meat and other foodstuffs made to UK standards will be allowed to enter Northern Ireland as long as they are labelled. Parcels to friends or family and shopping online will not require customs paperwork and businesses using approved parcel carriers will have simplified customs procedures.The ability for the UK to set VAT rules on some items, with the two sides drawing up a list of others.The ability for the UK to set excise duties according to alcoholic content and cut them for alcohol sold in hospitality locations (but not in shops where the bottles could move into the single market). Subject to EU minimum levels. British seed potatoes and plants can enter Northern Ireland. The Stormont brake, through which the assembly could ask the UK to block updates to single market rules that previously applied automatically in the region. Some of these changes require amending the protocol, including the brake. The two sides used Article 164 of the EU-UK Withdrawal Agreement, which enables them to revise the deals for up to four years in the event of “unforeseen” errors or omissions. The Commission will now present a proposal to change the Northern Ireland protocol to which a qualified majority of member states must agree. That is expected this month, diplomats say. Maroš Šefčovič, the commission vice-president in charge of Brexit, can then make the change in the Joint Committee, a body he co-chairs with UK foreign secretary James Cleverly. Other measures, such as medicines, require legislation with the European parliament involved as well, which could take a few months. EU diplomats say while there are questions about the Stormont brake — member states cannot pick and choose which rules they accept — they expect broad support for the deal. “No one wants to go back to the negotiating table,” said one. The brake can only be used “as a last resort”, the framework says, and if it is abused the EU can take “remedial measures” though these must be proportionate. Any disputes are resolved by international arbitration. EU diplomats dispute Rishi Sunak’s boast that he has secured a veto over updates to single market rules that apply in Northern Ireland. If the arbitration panel ruled the UK should apply it and it refused, it would undermine the entire framework and indeed put the post-Brexit tariff-free, quota-free trade deal at risk. However, no one wants to comment publicly until the prime minister has implemented the deal: it still has to pass a vote in the House of Commons and overcome possible resistance by the Democratic Unionist party.Simon Coveney, Irish enterprise minister, said earlier today that the EU needed to provide “reassurance to everybody who is asking questions” and “give people time and space to try to respond to this new agreement in a positive way”.As foreign minister until December, Coveney knows just how hard it was to secure a deal — especially when Boris Johnson and Liz Truss chose a path of confrontation with Brussels.“The most important thing . . . is the improvement in the trust between the Prime Minister’s office and the present European Commission. And the appetite to try to solve problems together in partnership is clearly now there,” he said.There are those who question whether the EU had shown too much faith in the British. The key breakthrough came in January when it was satisfied that the UK had a reliable system to track goods that the EU could look at in real time to check for fraud.“If the commission sees a vast increase in pork pies heading for Northern Ireland it can take action,” said one EU diplomat.Ireland also bolstered its market surveillance before Brexit. Now, market stalls and corner shops can expect more frequent visits from undercover inspectors looking for pork pies or titanium-laced cakes. Titanium dioxide, used to whiten foods such as chewing gum and cake icing, is banned in the EU as harmful but allowed in the UK — and therefore Northern Ireland under this deal. So while the UK stresses the freedoms Northern Ireland has gained the EU talks about safeguards. If banned goods or dangerous foods were found heading into Ireland and the single market it could revoke parts of the deal, for example demanding full customs checks again.“These reform proposals come with strings attached,” said Billy Melo Araujo, senior law lecturer at Queen’s University Belfast.“There are significant data sharing commitments taken by the UK, reinforced surveillance mechanisms that the UK has to put in place. “Based on recent history, to what extent will the UK actually invest in infrastructure and institutions which ensure surveillance, data sharing and enforcement of these rules on a continuous basis? We simply do not know.”That question is also being asked in EU capitals. Countries such as the Netherlands and Germany have long feared an influx of dangerous goods entering the single market across the Irish border. However, British officials say that after two years during which the UK refused to deploy the full controls on imports demanded by Brussels there has been no evidence of this happening — a fact which convinced them to effectively outsource border control to London.“It’s a system relying entirely on EU-UK trust now,” says Georg Riekeles, associate director at the European Policy Centre, who helped negotiated the original protocol. “They are using Article 164 to substantially empty/alter the protocol — on VAT and excise, agrifood, health standards, checks and controls.”For Northern Ireland’s sake, we must all hope that trust is justified. Brexit in numbers

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The Windsor framework has received almost universal acclaim. But one person with reservations is Wales’ first minister. Mark Drakeford told me on a visit to Brussels that the deal creates “perverse incentives” to move freight destined only for Northern Ireland to direct routes.That could divert trade away from the Welsh ports of Holyhead and Fishguard, which link Great Britain to Ireland. “We hope that there won’t be perverse incentives for firms to avoid ports where the direction of travel is directly to the Republic in favour of ports that operate directly between Northern Ireland and GB,” he said.“It’s a concern for us that we’ll be watching carefully.”Dublin to Holyhead, once the main route used by Irish hauliers taking goods to France and beyond over the so-called “land bridge”, has suffered already and is 30 per cent down on pre-Covid, pre-Brexit levels. Meanwhile ports such as Cairnryan, which serves Larne and Belfast, have had a boost.The Irish government said it was also alive to unforeseen impacts of the deal.Dublin port traffic has recovered almost to pre-Covid levels as customers switch from Holyhead to routes to France. But Irish minister Coveney said he would raise any negative impacts through the EU/UK Joint Committee that can change aspects of the protocol. Arriving for a meeting in Brussels, he said: “We want to make this work and we want to make sure that if there are any other issues that need to be teased through and resolved, that there is an appetite to do that in the appropriate structures that were put in place to do that, in this case, the Joint Committee.” Stena Line, the Swedish company that operates Holyhead port, also has direct routes from England and Scotland to Belfast. It welcomed the deal that “removes the notion of a border in the Irish Sea”.But Ian Hampton, Stena’s chief operating officer, said: “What we need now is alignment with Wales and the removal of the current disparity between the Republic of Ireland and Northern Ireland, because Britain intrinsically trades with the island of Ireland as a whole.”The company has joined a bid for a freeport in Holyhead, which would abolish many customs controls and simplify trade on these indirect routes to Northern Ireland.He added: “Restoring freight flows through the British land bridge will also lower costs for our customers in Ireland and on the continent.”Peter Foster is on leave, writing a book about Brexit and will return later this month.Britain after Brexit is edited by Gordon Smith. Premium subscribers can sign up here to have it delivered straight to their inbox every Thursday afternoon. Or you can take out a Premium subscription here. We welcome feedback so please get in touch via email at [email protected] or hit reply on this newsletter. More

UK businesses expect costs and inflation to ease but wage pressures to remain high, according to an influential Bank of England survey released on Thursday that could deepen divisions among policymakers on future interest rate rises.Responding to the central bank’s monthly decision maker panel for February, business leaders forecast output prices to increase by 5.4 per cent in the coming year. That is down from 5.8 per cent in January, and the lowest level since February 2022. The closely watched study, based on interviews with almost 2,500 chief financial officers, also found that businesses expected consumer price inflation to decline. DMP members’ expectations of one-year-ahead inflation fell to 5.9 per cent, down from 6.4 per cent in January.However, year-ahead wage growth averaged at a high pace of 5.7 per cent in February. That was unchanged from the previous month, but down from a peak of 6.3 per cent in December. Realised annual wage growth rose month on month by 0.3 per cent to 6.6 per cent. Meanwhile, cost pressures stayed high, rising by 9.8 per cent in the year to February, broadly unchanged from the previous month. But costs growth for the year ahead was forecast to ease to a rate of 7 per cent, down from 8 per cent in January.The survey’s findings come a day after BoE governor Andrew Bailey said he would not commit to further interest rate rises because the economy was “evolving much as we expected”. His comments were interpreted as pushing back against financial markets, which expect rates to increase from 4 per cent now to 4.75 per cent by the end of 2023. Members of the BoE’s Monetary Policy Committee have been split over interest rate raises at their past few meetings, with two voting to leave the rate unchanged in February and December. The combination of falling inflation expectations alongside strong wage pressures in Thursday’s data is likely to reinforce that divide.Markets are pricing in a rise of 25 basis points at the next MPC meeting on March 23, a slowdown from the 50bp increase announced in February. James Smith, economist at the bank ING, said that although Thursday’s data was unlikely to stop a quarter point rise this month, “if these trends continue through the spring, it suggests that this will mark the end of the current tightening cycle”.The survey, conducted by the BoE alongside academics from Stanford University and the University of Nottingham, also showed that forecasts for year-ahead employment growth rose to 2.7 per cent in February, up from 1.2 per cent from the previous month.Olivia Cross, economist at the consultancy Capital Economics, said Thursday’s data “certainly does point to resilient wage growth”, adding that “we haven’t yet seen signs of much looser labour demand”. Business leaders also reported a fresh rise in finding new staff in February, with 45 per cent saying that recruitment had been “much harder” than usual, compared with 35 per cent in January. Yael Selfin, chief economist at KPMG, an advisory firm, said that the “stronger wage momentum” caused by a relatively tight labour market “may make inflation a bit stickier but is unlikely to reverse the downward trend in inflation that we are expecting this year.” More

The writer is professor of economics and finance at UCL and director of the UCL Centre for FinanceGlobally, banks have been posting record increases in profits in 2022. In the UK for instance, Lloyds announced that profits almost doubled. One may wonder how bank profits can dramatically go up during a monetary policy tightening cycle. After all, banks are supposed to do maturity transformation: borrow short term and lend long term. When interest rates are going up sharply, this suggests a fall in net interest income and therefore a decrease in profits.In fact, net interest income for banks has dramatically gone up recently and is by far the key reason for the surge in bank profit. The increase in net interest margins in 2021-22 accounts for 60 per cent of the surge in profits, according to a recent report by McKinsey.Over the past five quarters, the Bank of England’s benchmark base rate went from 0.1 per cent to 4 per cent. While policy interest rate rises are quickly passed on to borrowers (as anyone with a mortgage well knows), they are barely transmitted to savers. As UK readers are probably aware, deposits rates went up only modestly since the beginning of the tightening cycle: the standard rates offered by the main British high street banks are still below 1 per cent (they were essentially at zero a year ago). But banks can now earn a base rate of 4 per cent by parking deposits at the central bank.

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One could expect one of these banks to compete to attract deposits by bidding up rates to take market share, say offering 2 per cent. Then another bank would bid up further, say to 2.5 per cent, and so on. Ultimately, competition would then bring the deposit rate closer to 4 per cent. The rate wouldn’t reach 4 per cent because the banks face costs of providing the services, but such costs are likely to be in basis points, rather than in per cents. Some closing of the gap should be expected in a competitive industry. That it does not happen is a strong sign of lack of competition and it is the main reason why bank profits go up when central banks sharply tighten monetary policy.The reason why competition does not play out here is not obvious as there seem to be enough banks, in principle to trigger such mechanisms. However, it is also true that the market is dominated by a small number of big players. Given that deposits are notoriously sticky (savers do not have the habit to shop around for better rates) it may be the case that no major player has an incentive to deviate and offer higher rates, as long as the others do not either.Lack of competition is an issue in general. While market power generates extra profits for shareholders and large compensations for managers, it makes consumers worse off. It also hurts the economy as a whole because the losses to consumers are greater than the gains for the firm. Beyond this traditional argument, there are here two additional concerns. Fortunately, there is also a simple remedy.The concerns are linked to high inflation. First, high inflation is the reason for nominal rate increases. But if increases are only partially transmitted to the real economy, higher nominal rates are likely to be needed to achieve the same tightening. In short, the lack of competition in the deposit sector impairs the transmission of monetary policy.Second, high inflation tends to disproportionally affect less financially sophisticated household. Such households are more likely to keep their savings as deposits than to invest them in bank equity for instance. If saving rates kept pace with nominal rate rises, this would mitigate the problem. Instead, the lack of competition in the deposit sector magnifies the cost of living crisis.The solution is simple: make interest payment on reserves conditional on banks passing the higher rates to depositors. For instance, the central bank could set a maximum margin as a condition. This is something it can do and should do, as this would improve the transmission of monetary policy, thereby making it easier to deliver on its price stability mandate. It would also help ease the burden on consumers during what BoE governor Andrew Bailey acknowledged this week as a cost of living crisis for many people. At the time when central bankers’ jobs is to take painful yet needed decisions, a simple reform that goes towards both easing their task and helping the public shouldn’t be overlooked. More

Brazil’s economy stagnated in the final quarter of 2022, underlining the challenges facing president Luiz Inácio Lula da Silva as he aims to boost living standards and reduce poverty following a divisive election.Gross domestic product contracted by 0.2 per cent in the last three months of the year from the previous quarter, when it expanded 0.3 per cent, according to official data released on Thursday. The weak performance, driven by shrinking industrial output and a cooling of services sector activity, interrupted five consecutive quarters of growth. Alexandre de Ázara, chief economist at UBS BB in São Paulo, said the deceleration reflected the lagged effect of monetary policy. The Central Bank of Brazil has undertaken aggressive tightening in an effort to contain inflation, raising its base interest rate from an all-time low of 2 per cent two years ago to 13.75 per cent in August.“There was also an increase in post-election uncertainty that caused a slowdown in investment, which had been the engine of growth,” said de Ázara.Latin America’s largest economy grew by 2.9 per cent overall in 2022, buoyed by the lifting of Covid-19 restrictions and stimulus measures, including fuel tax cuts and extra welfare payments, implemented under previous president Jair Bolsonaro in his failed re-election bid. However, it was a decrease from the growth rate of 5 per cent recorded in 2021 as the country recovered from the coronavirus pandemic. As high interest rates weigh on activity, the outlook is gloomier for Lula’s first year in office. Analysts predict annual economic expansion below 1 per cent for 2023. “The slow pace of global growth may contribute to Brazil’s GDP remaining weak this year,” said Cristiane Quartaroli, economist at Banco Ourinvest.The slowdown will complicate Lula’s ability to deliver on his campaign pledges. The veteran leftwinger began a third presidential term in January after a narrow victory over the far-right populist Bolsonaro in a run-off vote. Lula has promised to eradicate hunger and raise incomes with an increased minimum wage, social benefits and public works, but he faces strained public finances with little room for manoeuvre in the budget.The 77-year-old former metalworker, who last ruled between 2003 and 2010, has lashed out at the central bank over its benchmark lending rate, the second-highest among G20 nations after neighbour Argentina. Lula believes this is harming the wider economy and has questioned whether the institution should remain independent, sending jitters through the markets and leading investors to raise their inflation expectations. Although Brazil’s headline consumer price index has fallen below double-digit rates, at 5.8 per cent inflation remains above the official target of 3.25 per cent. Investors are also anxiously awaiting the formulation of a new fiscal rule governing the public accounts. During his election campaign Lula vowed to scrap a constitutional clause that pegs increases in state expenditure to the rate of inflation. It is considered by mainstream economists as key for keeping public spending in check and maintaining economic stability.“An interest-rate cut will only be possible if the government strengthens fiscal responsibility. While it remains unclear what rule will replace the spending cap, it will be very complicated,” said Camila Abdelmalack, chief economist at Veedha Investimentos.Additional reporting by Carolina Ingizza More

Pakistan’s central bank has raised lending rates by 300 basis points to 20 per cent, the highest of any country in Asia, as it struggles to contain rising prices and a deepening financial crisis.The announcement on Thursday came after the rupee fell more than 6 per cent against the US dollar. Foreign exchange traders had earlier sold off Pakistan’s currency in response to a delayed IMF loan.The interest rate rise is one of several measures Pakistan hopes will free up a stalled tranche of about $1bn held back by the IMF under its $6.5bn financing agreement with the country, which ends in June this year.Pakistan’s central bank said “anchoring inflation expectations is critical and warrants a strong policy response”. On Wednesday, the Pakistan Bureau of Statistics reported that inflation climbed to 31.5 per cent in February, up from 27.6 per cent a month earlier.The country has been hit hard by rising food and fuel prices and catastrophic floods last year, a crisis compounded by political tensions that have weakened the government of Prime Minister Shehbaz Sharif. His opponents say he has resisted making tough unpopular reforms for fear of losing support ahead of parliamentary elections due to be held by October.In recent weeks, the government has introduced austerity measures and raised a VAT-style sales tax. But critics say it has stopped short of raising the taxes of the politically influential elite such as landowners, industrialists and businessmen.Pakistan’s failure to secure IMF funding has caused the government’s foreign exchange reserves to sink to the equivalent of less than the cost of a month’s imports. Meanwhile, businesses complain of long delays in making payments for imports, often because of unofficial restrictions by the central bank. Companies such as automotive manufacturers have been forced to scale down production due to delays in imports of spare parts. Elsewhere, foreign airlines have faced delays in repatriating funds abroad.The rating agency Moody’s this week cut Pakistan’s sovereign credit rating by two notches to “Caa3”, saying the country’s “increasingly fragile liquidity and external position” had significantly raised the risk of default.Moody’s warned that “weak government and heightened social risks impede Pakistan’s ability to continually implement the range of policies that would secure large amounts of financing”.

“Pakistan’s economy is heading towards a very dangerous future. Our already sluggish growth will fall further. The new interest rate will make it impossible for many businesses to afford borrowings and still make money,” said Ihtisham ul Haque, a commentator on the Pakistan economy. “The situation has become very grim.”IMF managing director Kristalina Georgieva recently told German broadcaster Deutsche Welle that the multilateral lender was trying to help Pakistan avoid “a dangerous place where its debt needs to be restructured”. She denied Islamabad’s criticism that such measures would hurt the poor, arguing that rich Pakistanis benefited from government largesse. “It should be the poor to benefit from [subsidies],” she said. “We want the poor people of Pakistan to be protected.” More