Aurelia Butler

Two senior Federal Reserve officials have warned that failure to tame soaring inflation will damage the US economy, with one of them saying the situation is already testing the central bank’s credibility. Christopher Waller, a Fed governor, and James Bullard, president of the St Louis branch, used separate events to insist the central bank is committed to fighting runaway prices that have engulfed nearly every corner of the economy and appear increasingly at risk of becoming entrenched.“Inflation is a tax on economic activity, and the higher that tax, the more it suppresses economic activity,” Waller said at an event hosted by the National Association for Business Economics. “So if we don’t get inflation under control, inflation on its own could put us in a really bad economic outcome down the road,” added Waller, who like Bullard, is one of the most hawkish policymakers. The foremost concern is that elevated inflation — now running at the fastest pace in roughly four decades — will alter expectations about the price outlook and lead households and businesses to anticipate future increases. That risks sparking a destabilising cycle that leads to an even worse inflation problem.“The whole thing we know about expectations [is] once they become unanchored, you’ve lost,” said Waller. For that reason he said the Fed is “dead set” on getting inflation under control. Waller underscored that the Fed will not allow for a repeat of the 1970s, when the central bank’s credibility was called into question, inflation expectations soared and then-chair Paul Volcker was forced to dramatically raise interest rates, which led to widespread economic damage.Those concerns were echoed by Bullard, who spoke on Thursday at an event organised by the Little Rock Regional Chamber in Arkansas. He warned that the economic situation is already “straining the Fed’s credibility with respect to its inflation target”.At an annual rate of 4.7 per cent as of May, so-called core PCE inflation — which strips out volatile items including food and energy — is well above the Fed’s 2 per cent target.Waller and Bullard support the Fed delivering another 0.75 percentage point rate rise when its monetary policy committee convenes again late this month, after it made the first such increase since 1994 when it met in June. By year end, most officials believe the benchmark federal funds rate should hover at about 3.5 per cent, up from its current range of 1.50 per cent to 1.75 per cent. Such a level would begin to curtail economic activity, Fed chair Jay Powell has said.

Minutes from the June meeting, released on Wednesday, also suggested that rates could become “even more restrictive” if price growth is not sufficiently contained. As the Fed decides on the trajectory of future rate increases, it will be looking for clear-cut signs of a deceleration in the pace of monthly inflation. Officials also appear more willing to make sacrifices in the labour market in their bid to stamp out inflationary pressures. “We may have to take the risk of causing some economic pain,” Waller said on Thursday, although he stressed recession fears are “overblown”.Like Waller, Bullard still sees a “good chance” of a soft landing, in which the Fed can bring down inflation without leading to painful job losses. More

Boris Johnson’s departure from office will have less international impact — particularly on Britain’s relations with the EU — than his arrival as the prime minister who claimed he would “get Brexit done”, diplomats say.In theory, his exit offers the chance for a reset in fractious bilateral relations between the UK and EU. But most in Brussels believe his successor will continue with plans to unilaterally amend the post-Brexit trade deal he signed.“We are by no means jumping for joy,” said an EU official. “It doesn’t look as if another candidate would change course drastically in their attitude.” Several diplomats questioned whether any contender for the Conservative leadership would dare to discontinue a policy popular with the MPs whose support they must win. “Even though Johnson is gone, it’s the same party with the same backbenchers,” said one diplomat. Most European capitals, especially Paris, had lost trust in Johnson despite his claim for credit in his resignation speech for “settling our relations with the continent”. He agreed an exit deal with the EU that sowed the seeds of discord. Johnson wanted the UK to be free to diverge from EU rules and sign trade deals with other countries. That meant keeping Northern Ireland in the EU single market for goods while Great Britain left. Doing so avoided a trade border on the island of Ireland but required one in the Irish Sea, which angered Northern Ireland unionists. In June, Johnson’s government proposed legislation that would override much of that arrangement.The betrayal poisoned the atmosphere with Brussels. “We signed with the same people. We negotiated with these people and they signed the agreement. Now they are trying to undo what [they] said was a good deal,” said one official involved in the original Brexit deal.Pascal Lamy, a former French commissioner, told the FT: “What we can expect is a change of style — a more boring style of politics and no more fireworks. There is no one else like him in British politics. That would allow us to focus on the boring and highly technical task of agreeing how to administer the Northern Ireland border. A return to calm is a prerequisite to a more normal relationship.”Micheál Martin, prime minister of Ireland, said: “We have now an opportunity to return to the true spirit of partnership and mutual respect.”A thaw in Anglo-French relations also seemed illusory. On Wednesday, British officials were talking about plans for a formal bilateral summit between Johnson and French president Emmanuel Macron — the first since a meeting between Macron and Theresa May in January 2018. But the French have been noticeably less enthusiastic about the so-called “bromance” that Downing Street said had developed between the two leaders at the recent G7 summit in Germany. “It’s not possible to go on like this,” said one French official this week.On the other big international issue of recent months — war in Ukraine — Johnson’s announced departure was lamented in Kyiv. Ukraine saw Johnson as a staunch supporter of its resistance to Russia’s invasion and expects him to be replaced by someone equally keen to send arms.“We have no doubt that Great Britain’s support will be preserved, but your personal leadership and charisma made it special,” Ukrainian president Volodymyr Zelenskyy said.In Moscow, though, Johnson’s exit was predictably mocked. “Boris Johnson was hit by a boomerang launched by himself,” said Maria Zakharova, Russia’s foreign ministry spokesperson. “His comrades-in-arms turned him in.” 

The UK’s stance on Northern Ireland and Johnson’s ties to ex-US president Donald Trump have also damaged relations with Washington under Joe Biden. The state department and many members of Congress have repeatedly urged Johnson to negotiate over the protocol.“I look forward to continuing our close co-operation with the government of the United Kingdom,” Biden said in a White House statement that did not mention Johnson by name.Additional reporting by Valentina Pop, Victor Mallet, Jude Webber and Roman Olearchyk More

In normal circumstances, US President Joe Biden and Amazon founder Jeff Bezos would not pick a fight with each other over inflation. But these are not normal circumstances today in America.With inflation hitting 8.6 per cent in May, and the Atlanta Federal Reserve’s Nowcast series signalling an economic contraction in the second quarter of this year, Biden is desperate to find anything, or anyone, to blame.So he has recently attacked gas companies, ordering them to cut soaring fuel prices at “a time of war and global peril”. Which, inevitably, has sparked fears of rising anti-business populism among executives — prompting Bezos to lash out against Biden’s “deep misunderstanding” of economics. It makes for headline grabbing stuff. But it is also a smokescreen. For the real issue that Bezos and Biden ought to talk about, but almost certainly will not, is wages. Back in May, the three-month average rate of annual wage growth was 6.1 per cent, according to the Atlanta Fed, double what it was a year ago. And unlike previous decades, when wage gains almost exclusively went to highly paid workers, the low-paid have benefited too. Amazon raised its average annual pay to $18 an hour, from $17 six months earlier and $15 in 2018.In many ways, this is profoundly good news for Biden, given that progressives have long complained (quite rightly) that the US is beset with widening income inequality and been viscerally critical about Amazon’s treatment of workers. But the rub is that Biden also faces a Federal Reserve whose officials now fear that elevated inflation “could become entrenched” in public expectations, according to the minutes of the last Fed meeting released this week. This means the White House has every incentive to fear rising wages — while also wanting to encourage them. The Bank for International Settlements’ latest annual report lays out the dilemma with particular clarity, not just for the US but for all western countries. This starts by noting that the difference between low-inflation and high-inflation regimes is not just price levels, but whether there is price contagion. In low inflation regimes, idiosyncratic price rises (like an oil price jump) do not cause all prices to rise; in high-inflation regimes, however, they do. This reflects behaviour and psychology, the BIS notes, such as the degree to which companies pass costs on and workers organise themselves to demand wage increases that keep pace with inflation. In the 1970s, it was the latter, partly because there were strong unions, centralised salary negotiation mechanisms and wages were often indexed to inflation. But big “structural changes” in subsequent decades caused the collapse of workers’ “pricing power” in advanced economies: the BIS cites novel, eye-catching research showing that while 70 per cent of countries were using contracts with price indexation in 1975, barely 10 per cent did in 2015. Similarly, while more than 90 per cent of countries had some wage co-ordination in 1980, by 2020 it was only 60 per cent.This fall is usually blamed on rightwing government policies such as curbs on unions, coupled with demographic shifts like the entry of low-cost overseas workers into the global system. But the BIS thinks there is also a less-acknowledged feedback loop, creating a vicious or virtuous cycle. “The higher the inflation rate, the greater the incentive for workers to unionise, and for wage negotiations to be centralised . . . and the more persistent the inflation rate, the greater the incentive to index wages,” it notes. However, in low inflation regimes, workers feel less need to organise themselves to exert pricing power. Hence Biden’s dilemma. He came to office championing the rights of America’s now-shrivelled unions. And Jennifer Abruzzo, his key labour relations official, told the FT this week that the administration will support the unionisation now seeping into companies such as Starbucks, Apple and Amazon. America, like other western countries, is also seeing more industrial action, and there are now “demands for greater centralisation of wage negotiations or indexation clauses”, the BIS notes.This terrifies central bankers. But, as Adam Tooze, a Columbia University professor, notes in a trenchant essay on the BIS report, any “technocrat who celebrates the decline of the bargaining power of organised labour because it makes inflation-control easier” looks politically naive, or blind; it risks stoking “troublesome populism”.Of course, Tooze also notes, there is a potential alternative: politicians, executives and central bankers could talk about “distributional” issues. They might, say, (re)embrace the concept of “liberal corporations”, and use centralised wage setting systems to ensure that lower paid workers got more wage rises than higher paid ones.But, he notes, the BIS report ducks these political explosive issues. And even if Biden’s team wanted to embrace distributional policies, they have little power to do so; telling Amazon to give more money to warehouse workers, while cutting executive pay, would unleash (more) Bezos attacks. Hence why both men prefer to talk about oil prices — and fervently hope that somehow wage growth gently declines as economic activity weakens, before the “entrenched” inflationary psychology that worries the Fed sets in, and/or there is a full-blown recession or an explosion of populism. It will be a miracle if America can avoid all three [email protected] More

Good news, everyone. We did it!From Deutsche Bank this morning, with our emphasis: The USD break-even market is pricing that US inflation will be back to target within three years. Assuming a 50bp PCE/CPI wedge, 2y1y break-evens are back in line with the 2% Fed target. This is happening while the market is pricing peak Fed funds just at 3.4%. This is just above the lower end of our estimated terminal rate range of 3.25-4.25%. While such outcome is plausible, the risks remain biased towards the Fed ultimately hiking more than currently priced in. However, given the bullish rate seasonals we maintain low risk for now.The straightforward argument here is that the bond market is signalling the Federal Reserve will succeed in getting inflation back to 2 per cent. The implied argument is that the Fed won’t have to raise rates too much higher to do so; at 1.75 per cent, the US policy rate is now more than halfway to its market-forecast peak of 3.4 per cent.Break-even rates are supposed to be the evidence for this. Many of our readers already know that break-evens are the inflation rate where Treasury Inflation-Protected Securities (or TIPS, the US version of linkers) are just as attractive as nominal Treasuries, so academics and commentators often use them as a real-time measure of the market’s inflation expectations. Some of our readers already know why decomposing rates can be a silly exercise. The Deutsche Bank note says markets are predicting inflation will recede to 2 per cent between mid-2024 and mid-2025 — based on 2-year 1-year forward break-even inflation rates.

Congrats! © Deutsche Bank

If the chart gives you a headache, there is good reason. First, short-dated TIPS aren’t especially liquid, as the US doesn’t issue new TIPS with maturities shorter than 5 years. And instead of using break-even rates for the illiquid short-dated TIPS, Deutsche Bank uses forward break-even rates in the market for illiquid short-dated TIPS. To make their case, the strategists are also required to subtract half of a percentage point from that break-even rate. TIPS are priced on the consumer price index, while the Fed targets a broader measure, the price index for personal consumption expenditures, which do typically run below the CPI. As Bespoke’s George Pearkes observed many years ago, it is tricky to draw conclusions from forward rates. And nearly everyone has observed that break-evens are highly correlated with oil prices in ways that undermine their reliability as an indicator of future inflation. Energy and commodities melted down earlier this week, and West Texas Intermediate crude futures are still down 4% for the week even after a Thursday rebound. Technical factors seem to be driving a lot of the move. This doesn’t necessarily mean that the Deutsche Bank strategists’ conclusions are wrong. It is possible that the Fed won’t have to raise rates much more before inflation decelerates. But perhaps instead of looking at a forward rate in an illiquid section of an already-illiquid yield curve that is very closely tied to oil prices, it could be more sensible to just look at oil prices instead. More

Some eurozone rate-setters think the European Central Bank may need to raise interest rates more aggressively than planned, an account of last month’s policy vote confirmed. The worry that consumer prices will become embedded at levels far above its 2 per cent target led the ECB’s governing council to stop printing more money for bond purchases last week and in early June to announce plans to raise rates for the first time in a decade. The central bank has said it intends to raise its deposit rate by a quarter percentage point to minus 0.25 per cent on July 21, followed by a bigger rise in September unless inflation cools quickly.But some council members want it to move more quickly, according to the minutes of the June 9 meeting in Amsterdam. The minutes, published on Thursday, said: “A number of members expressed an initial preference for keeping the door open for a larger hike at the July meeting.”Some members of the council have called for a rise of 50 basis points later this month to counter record-high inflation. Data last week showed consumer prices rose by a record 8.6 per cent in the year to June, up from 8.1 per cent in May and bolstering calls for a bigger rise. Most economists expect the ECB to stick to its plan for a 25 basis point rate rise in two weeks’ time. Carsten Brzeski, head of macro research at ING, said this scenario “remains in place” even if the “door is still open” for a bigger move.The minutes highlighted policymakers’ fears that inflation could become entrenched, saying “persistently high energy and food prices, inflation expectations rising above target and higher than anticipated wage rises” were among the risks to the outlook. “The risk of an unanchoring of inflation expectations was seen as particularly high when inflation expectations adapted to recent developments,” the minutes said. However, they added that “if demand were to weaken over the medium term, it would lower pressures on prices”.An ECB survey of eurozone businesses, also published on Thursday, found over 70 per cent had increased their selling prices over the past year and three-quarters of them expected to do so over the next year. Only 3 per cent expected to cut their prices.The minutes also showed ECB policymakers expected growth “over the next few quarters would be weak and the risk of a technical recession needed to be borne in mind”.The ECB thinks the economy could shrink by 1.7 per cent next year, should the war in Ukraine lead to a complete cut-off in Russian energy supplies. “In particular, a further disruption in the energy supply to the euro area would be a major risk,” the minutes said.

BusinessEurope, an umbrella group of European business federations, on Thursday slashed its growth forecasts for the eurozone to 2.5 per cent this year and 1.9 per cent next year, while warning “individual member states may experience at least ‘technical recessions’ in 2022”.Rate-setters face a balancing act between reversing almost a decade of ultra-loose monetary policy to address soaring prices while trying to avoid another debt crisis in Europe. Borrowing costs for heavily indebted countries such as Italy have risen more sharply in recent months than those of more frugal member states such as Germany — a problem the ECB refers to as “fragmentation risk”. The minutes of last month’s meeting reveal that some of the 25-member governing council called for work on a possible new tool to counter the risk of a fresh crisis to “be accelerated and completed rapidly since the risk of fragmentation could intensify”. However, it was almost a week later before the ECB announced after an emergency meeting that it would speed up work on the tool. The planned instrument, which the ECB has given a working name of the Transmission Protection Mechanism, was discussed at a meeting of the ECB council on Wednesday, though no final decisions were taken. More

LONDON (Reuters) -Scandal-ridden Boris Johnson announced on Thursday he would quit as British prime minister after he dramatically lost the support of his ministers and most Conservative lawmakers, but said he would stay on until his successor was chosen.Bowing to the inevitable as more than 50 ministers quit and lawmakers said he must go, an isolated and powerless Johnson said it was clear his party wanted someone else in charge.”Today I have appointed a cabinet to serve, as I will, until a new leader is in place,” Johnson said outside his Downing Street office where his speech was watched by close allies and his wife Carrie.”I know that there will be many people who are relieved and perhaps quite a few who will also be disappointed. And I want you to know how sad I am to be giving up the best job in the world. But them’s the breaks.”Johnson gave no apology for the events leading to his announcement and said his forced departure was “eccentric”.There were cheers and applause as he began his speech, while boos rang out from some outside the gates of Downing Street.After days of battling for his job, Johnson had been deserted by all but a handful of his closest allies after the latest in a series of scandals broke their willingness to support him. The Conservatives will now have to elect a new leader, a process which could take weeks or months, with details to be announced next week. A snap YouGov poll found that defence minister Ben Wallace was the favourite among Conservative Party members to replace Johnson, followed by junior trade minister Penny Mordaunt and former finance minister Rishi Sunak.While Johnson said he would stay on, opponents and many in his own party said he should leave immediately and hand over to his deputy, Dominic Raab.Keir Starmer, leader of the main opposition Labour Party, said he would call a parliamentary confidence vote if the Conservatives did not remove Johnson at once.”We can’t go on with this prime minister clinging on for months and months to come,” he said.The crisis comes as Britons are facing the tightest squeeze on their finances in decades, in the wake of the COVID-19 pandemic, with soaring inflation, and the economy forecast to be the weakest among major nations in 2023 apart from Russia. It also follows years of internal division sparked by the narrow 2016 vote to leave the European Union, and threats to the make-up of the United Kingdom itself with demands for another Scottish independence referendum, the second in a decade. Support for Johnson had evaporated during one of the most turbulent 24 hours in recent British political history, epitomised by finance minister, Nadhim Zahawi, who was only appointed to his post on Tuesday, calling on his boss to resign.Zahawi and other cabinet ministers went to Downing Street on Wednesday evening, along with a senior representative of those lawmakers not in government, to tell Johnson the game was up.Initially, Johnson refused to go and seemed set to dig in, sacking Michael Gove – a member of his top ministerial team who was one of the first to tell him he needed to resign – in a bid to reassert his authority.But by Thursday morning as a slew of resignations poured in, it became clear his position was untenable.”You must do the right thing and go now,” Zahawi tweeted. Some of those that remained in post, including Wallace, said they were only doing so because they had an obligation to keep the country safe. There had been so many ministerial resignations that the government had been facing paralysis. Despite his impending departure, Johnson began appointing ministers to vacant posts.”It is our duty now to make sure the people of this country have a functioning government,” Michael Ellis, a minister in the Cabinet Office department which oversees the running of government, told parliament.FROM POPULAR TO DESERTEDThe ebullient Johnson came to power nearly three years ago, promising to deliver Brexit and rescue it from the bitter wrangling that followed the 2016 referendum. He shrugged off concerns from some that his narcissism, failure to deal with details, and a reputation for deceit meant he was unsuitable.Since then, some Conservatives had enthusiastically backed the former journalist and London mayor while others, despite reservations, supported him because he was able to appeal to parts of the electorate that usually rejected their party.That was borne out in the December 2019 election. But his administration’s combative and often chaotic approach to governing and a series of scandals exhausted the goodwill of many of his lawmakers while opinion polls show he is no longer popular with the public at large.The recent crisis erupted after lawmaker Chris Pincher, who held a government role involved in pastoral care, was forced to quit over accusations he groped men in a private member’s club. Johnson had to apologise after it emerged that he was briefed that Pincher had been the subject of previous sexual misconduct complaints before he appointed him. The prime minister said he had forgotten. This followed months of scandals and missteps, including a damning report into boozy parties at his Downing Street residence and office that broke COVID-19 lockdown rules and saw him fined by police over a gathering for his 56th birthday.There have also been policy U-turns, an ill-fated defence of a lawmaker who broke lobbying rules, and criticism that he has not done enough to tackle inflation, with many Britons struggling to cope with rising fuel and food prices. In his resignation speech, Johnson highlighted his successes – from completing Brexit to ensuring the fastest COVID-19 vaccine rollout in Europe. But he said his attempts to persuade colleagues that changing leader while there was war in Ukraine and the government was delivering on its agenda had failed.”I regret not to have been successful in those arguments. And of course, it’s painful not to be able to see through so many ideas and projects myself,” he said. “But as we’ve seen at Westminster the herd instinct is powerful – when the herd moves, it moves and, my friends, in politics no one is remotely indispensable.” More