Aurelia Butler

(Reuters) – U.S. Federal Reserve officials have aligned around plans to accelerate the pace of interest rate hikes this year but remain split over what could be the make-or-break decision of where to stop to avoid dragging the economy into recession.That debate is only beginning but will become more critical this summer as policymakers gauge how quickly their initial rate increases cause households and firms to slow spending and whether that, in turn, slows the pace of inflation running at levels not seen since the 1980s.A recent rise in long-term interest rates has done little yet to improve the inflation outlook and left the Fed at a risky juncture – torn between an even more aggressive pace of rate hikes that may push the economy backwards, or moving too slowly and allowing an inflationary psychology to take hold. “Ultimately it’s making a decision…’this is a path that seems consistent (with controlling inflation)’…Or judging that it’s not the case,” Chicago Fed President Charles Evans said last week, outlining the struggles Fed officials anticipate in determining how high rates may need to rise to bring inflation back in line with the central bank’s 2% target. “It’s a devilishly hard question,” Evans said. The current economic expansion depends on the Fed getting the answer right, and not everyone thinks they will. Former Treasury Secretary Lawrence Summers, who has argued forcefully the Fed waited too long to respond to price increases, recently wrote that inflation this high – last at 6.4% by the Fed’s preferred measure – coupled with low unemployment makes a recession likely within two years.GRAPHIC: “Broad-based” or not? “Broad-based” or not? – https://graphics.reuters.com/USA-FED/INFLATION/klpykzrowpg/chart.png ‘EXTREMELY IMPORTANT DEBATE’ The Fed will take the next step in its policy shift during a meeting May 3-4 when officials are expected to increase the target policy rate by half a percentage point.Even the most dovish policymakers, including Evans, now agree that rate hikes in increments beyond the familiar quarter-point-per-meeting are needed, given the strength of inflation. They also have coalesced around an overall increase of the federal funds rate to at least 2.5% by year end from the near-zero level set to fight the steep but brief recession caused by the coronavirus pandemic. Consumers, businesses and financial markets have largely taken that much tightening in stride.But it may not prove enough. Analysts note that periods of high inflation can generate their own momentum, lifting the effective level of rates needed to blunt price increases.The rate where interest rate increases meaningfully influence the economy “could be higher than it otherwise would be because of what’s going on with inflation, and that’s partly what’s driving them to be more comfortable with going higher, faster,” Nomura Research economist Robert Dent said. “It’s an extremely important debate that will get more attention at the Fed in the next six months.” At their last meeting in March, the range of rates policymakers projected as appropriate by the end of 2023 ran from 2.1% to 3.6%, a cavernous gap reflecting risks around the pandemic, the Ukraine war, and other largely uncontrollable forces, but also pointing to uncertainty over how businesses and consumers might react to higher borrowing costs.Equity markets have been rocked by volatility in recent days in part, Bank of America (NYSE:BAC) economists argued in an analysis, because the berth around possible Fed policy paths is currently so wide, with options contracts indicating the central bank’s policy rate could top out anywhere between 2% and 4.5% over the next two years.GRAPHIC: A fast trip to neutral – https://graphics.reuters.com/USA-ECONOMY/POWELL/zdvxogolapx/chart.png FINDING ‘NEUTRAL’In debating monetary policy Fed officials use a concept known as the “neutral” or “natural” rate of interest to judge whether the rate they set for overnight loans between banks, a key figure that influences borrowing costs more broadly, is encouraging or discouraging economic activity. Over the long-term it is the rate considered to balance the economy across a number of fronts while maintaining full employment, inflation at the Fed’s target, and output growing at a rate consistent with underlying productivity, demographic and other trends.GRAPHIC: ICE (NYSE:ICE) inflation expectations index ICE inflation expectations index – https://graphics.reuters.com/USA-FED/INFLATION/akvezxjwrpr/chart.png Fed officials currently estimate the neutral rate to be around 2.4% and have committed as a group to reach that level “expeditiously” in one of the fastest monetary policy shifts ever undertaken by the U.S. central bank.But if the next few weeks or months veer from the Fed’s baseline outlook – if consumers alter their spending or businesses begin setting wages and prices differently than anticipated because their own expectations or preferences have shifted – policymakers may have to get more aggressive.As a short-term concept, “neutral” may have moved higher because of the very inflation dynamics the Fed is trying to fight, potentially forcing the central bank to play catch-up. Some, like St. Louis Fed President James Bullard, argue they are in fact already “behind the curve” and may need to move rates faster and higher than planned.GRAPHIC: A bumpy landing? – https://graphics.reuters.com/USA-ECONOMY/RECESSIONTEMPLATE/egpbkoolgvq/chart.png ‘WALL OF WORRY’ Fed officials want to keep the recovery on track and avoid in particular any large jump in unemployment from the current 3.6%, arguably the strongest job market since the 1950s.But that means they need to take the edge off some of the current economy’s extremes, be it the 35% jump in median home prices during the pandemic, or wage increases that Fed Chair Jerome Powell has dubbed “unsustainably hot.”GRAPHIC: Fed policy trails inflation by historic margin Fed policy trails inflation by historic margin – https://graphics.reuters.com/USA-FED/gdpzynrmnvw/chart.png Inflation data this week will show whether any progress is being made, and the April employment report released next week will provide an update on wage growth.There is some initial evidence the housing market is beginning to cool as home mortgage rates exceed 5%, compared with around 3% last year. But the issues around the Fed’s policy path are still far from resolved. Many economists recently raised their estimates of how much the Fed will need to do and look to next week’s meeting for guidance.The job market and related wage growth remain strong, and unemployment could dip below 3% this year, Jefferies economists projected recently. Consumers so far have been impervious to “Omicron, Ukraine invasion, a spike in gas prices and sharply higher interest rates,” economists Aneta Markowska and Thomas Simons wrote. For the Fed that could mean pushing rates to more than 4%, a level not seen since before the 2007-to-2009 financial crisis and one that would likely raise recession risks.”The U.S. economy is climbing the wall of worry,” they wrote, with inflation broadening and the economy’s underlying strength meaning that “the Fed will have to be even more aggressive.” More

COLOMBO (Reuters) – Many schools in Colombo were shut and several train stations deserted on Thursday as teachers and train drivers joined mass walkouts demanding President Gotabaya Rajapaksa’s government quit over Sri Lanka’s worst financial crisis in decades. Hundreds of employees from Sri Lankan state-run banks, most wearing black and carrying black flags, also joined other bank trade unions in a protest march to the president’s office as thousands of people took to the streets around the country.The pandemic, rising oil prices, populist tax cuts and rapidly dwindling foreign currency reserves have left Sri Lanka without enough dollars to pay for vital imports of fuel, food and medicine. Sometimes violent street demonstrations have erupted this month as shortages and power cuts became acute.”This government has ruined our country. Costs are increasing every day, businesses are closing, and people have no way to live. There is no fuel, when we go home there is no electricity and no cooking gas to make meals,” said Samanthi Ekanayake, 34 who works as a teller at a state-run bank.”We are tired of broken promises.”The country’s trade union leaders have threatened an ongoing strike from May 6 if the president and the government do not resign.   Rajapaksa this week reiterated his willingness to form an interim government with a new prime minister and cabinet. However, Prime Minister Mahinda Rajapaksa, who is his elder brother, has declined to step down and insisted he continues to have a majority in the 225-member parliament. Meanwhile, two Opposition parties, the Samagi Jana Balawegaya (SJB) and the Tamil National Alliance (TNA) have started the process to bring no-confidence motions against the president and prime minister in parliament. “Political instability will only make it more difficult to provide solutions to the financial crisis. So it is imperative a strong government with a clear majority is established in parliament and the government is working towards this goal,” Cabinet spokesman Nalaka Godahewa said.  More

Investing.com — Glencore stock rose on Thursday after the world’s biggest mining company predicted another year of solid profits due to high prices for its main commodities.The London-listed mining giant said its earnings before interest and taxes would be “comfortably” above $3.2 billion, the top end of its guidance range, the third year in a row it has been able to deliver such a result.By 5:55 AM ET (0955 GMT), Glencore (OTC:GLNCY) stock was up 2.1% in London and is now up 31% for the year, making it the best performer among the major European-listed mining groups.Glencore’s forecast is in some ways an illustration of the traditional preference of mining companies for price over volume. The company had to lower its production guidance for zinc, cobalt and copper, its main earnings generator, due to Covid-19 lockdowns and associated labor shortages, as well as other operational problems.Copper production fell 14% in the quarter, while zinc production fell 15%, due largely to delays at its Zhairem operation in Kazakhstan. Glencore cut its full-year guidance for zinc output by 9%, its copper guidance by 3.5% and its cobalt guidance by 6.5%.However, it nudged up its forecasts for nickel and ferrochrome production by just under 3% each.Glencore is a significant player in nearly all major industrial metals except steel. The struggle of Glencore and its peers to sustain output during the pandemic has been a major contributing factor to the rallies in world metals prices in that time. More

In the gunfight at noon-style stand-off that is the Russia-EU mutual energy trade dependence, it seems like Russia has drawn first. Early this week, its state-owned gas company, Gazprom, cut off supplies to Poland and Bulgaria, sending gas prices soaring.We are now in a situation I warned about at the start of the war. While it could be painful in the short run for European countries to go “cold turkey” on Russian gas and oil, it is surely better to do so of one’s own volition than to be forced into it at a time of Vladimir Putin’s choosing.True, Europe has taken steps to begin weaning itself off Russian energy, and the destination seems clear. A coal embargo has been agreed, there is now talk of “smart” sanctions on oil, and even Germany aims to phase out Russian gas (by 2024). But so far outright bans on oil or gas have been a step too far. That is why clever alternatives such as import taxes or price ceilings are now a hot topic in Brussels. No less a policymaker than US Treasury secretary Janet Yellen called for caution on outright bans last week, in warning that an oil embargo could lead to higher world prices, and then “although Russia might export less, its price for its exports would go up”. It is unclear — at least to me — how helpful Yellen’s intervention was, if it supports those in the EU who are holding back the effort to cut Russian energy imports. She did not elaborate on how she sees a withdrawal of western demand for Russian oil and gas leading to higher Russian revenue. It presupposes that Russia could sell enough elsewhere, where prices would go up due to relocated western demand (on which more below). But in any case, surely the greatest risk of the outcome she fears is that western countries do not cut demand but Russia cuts supply. Witness today’s situation in Europe, where Putin has withheld less than 10 per cent of its sales but caused prices to go up by 20 per cent, netting the Kremlin a nice windfall.Be that as it may, ever since Putin sent his army into Ukraine, economists have been in overdrive devising schemes to maximise the damage to Moscow’s energy earnings while minimising the harm to European oil and gas users. That is presumably what any forthcoming “smart” sanctions will aim to achieve. How would they work? Let’s look at the mechanics of a tax on Russian oil or gas imports, which has received most attention from economic experts (other versions would be a price cap or a buyer’s cartel arrangement).Daniel Gros and John Sturm both have good explainers of the economics of a special energy tariff. These are in essence based on the classic argument of the optimal import tariff for a country that can influence its own terms of trade. The main idea here is that insofar as Russia depends on the EU market to sell its oil and gas, it will not completely withdraw supply if it does not get the same price as before, but will accept some of the pain of a tariff in the form of lower (pre-tariff) selling prices to ensure buyers do not reduce their demand too much. An important implication of this is that even if there were no geostrategic goals, the EU would have a commercial interest in imposing a tariff on Russian energy imports. It could be set so that customs revenue would be more than enough to compensate those who lose out from energy prices (inclusive of tariffs) going up. Gros puts this economically optimal tariff level at 30 per cent, and at double that if the EU values the loss of income to Russia as much as it values its own price paid.Going further than this, Ricardo Hausmann proposed right after Russia’s invasion a punitive tax of 90 per cent of the purchase price, with the purpose of expropriating the natural resource rent enjoyed by the Russian state (the price paid over and above Russia’s low costs of extraction).Again, all this depends on the degree to which Russia would keep delivering oil or gas even if the price it received fell. And that in turn depends on technological, economic and legal factors. Technologically, things look good. “Available estimates put average Russian crude oil production cost at between $20 to $30 per barrel,” says Laura Solanko at the Bank of Finland’s Institute for Emerging Economies. In addition, “some experts claim that a very large share of Russian oil wells is geologically difficult to shut and reopen. Therefore, Russian producers are likely to favour producing even if [the] price level is below $30/bbl. This has indeed been the case in the past as well.”Similar points can be made for natural gas — it is not straightforward to manage a reservoir’s pressure if you are going to turn the gas on and off regularly. So Russia probably needs to offload its oil and gas because it cannot easily cut production by a lot in the short term. Could it take it to other markets if it stopped selling to Europe? Not gas — there is no capacity for years to send current pipeline gas elsewhere. As for oil, this is easier — but tanker capacity would need to be found, and the steep discount at which Russian oil is currently trading shows there is quite a bit of “self-sanctioning” going among buyers and/or shippers.But oil can at least be shipped elsewhere. An oil embargo would withdraw demand for Russian oil in Europe but increase demand for non-Russian substitutes. By itself this would create a huge incentive for a carousel trade shipping Russian oil to non-sanctioning markets, and redirecting their previous supply from non-sanctioned producers to the EU. Russian exports are a tenth or so of global exports, so this should be possible. The result would drive up oil prices by the added transport costs everywhere, but they would still be similar around the world and Moscow’s bank accounts would not be appreciably lighter than now.But here is where the legal elements come in. To avoid the result Yellen warns against, the west would in essence have to try to segregate the global markets for Russian and non-Russian energy goods. Anette Hosoi and Simon Johnson have shown how this must be done in an oil embargo. In addition to banning imports, the EU and its allies should also prohibit any tankers owned or controlled by people linked to their jurisdictions from transporting Russian oil and sanction any financing of the Russian oil supply chain. Such auxiliary measures are essential to make any restriction on imports of Russian energy work as intended. But if the EU could do this, might it not as well go for an outright ban? The economic modelling of a tax or tariff, which concludes that Russia would lower prices to compensate, glosses over the mechanics of price adjustment. The way Russia would be “forced” to cut prices is that EU buyers would withdraw demand if they had to pay the full tariff. But the political resistance to import bans, as well as the claims that it is physically very hard to substitute away, suggest otherwise. One advantage of a tax or tariff over the alternatives is judicial. Tariffs could be justified on the grounds of trade or energy policy, which may not require unanimity in the EU, unlike sanctions. But this may be a politically risky way to go if it is important to keep Germany on board.In the end, then, a tariff and a ban look fairly similar. So they should best be thought of as steps in the same process. The best case for a tariff is that it can be introduced immediately and turned up over time. And crucially, if a steeply rising path of the tariff is agreed and announced today, companies will be given the best possible conditions to adapt. An immediate tariff, to be stepped up to reach prohibitive levels soon, and accompanied by further financial and shipping sanctions, is what the EU should now adopt.Other readablesIt would have been the top news were it not for the war: Brussels has triggered the EU’s new rule of law mechanism for the first time, against Hungary. The mechanism allows it to withhold EU funds from the country.New research provides the most solid evidence so far that Brexit badly harmed the UK’s trade with the rest of Europe. The number of buyer-seller relationships fell by one-third, and the range of goods traded also fell.As attention turns to Ukraine’s reconstruction, Adam Tooze goes through the debate over the original Marshall plan. While its economic impact has been contested, its political importance is undeniable.Numbers newsThe French election in numbers and charts.The latest forecast from The Vienna Institute for International Economic Studies sees gross domestic product collapse by up to 45 per cent in Ukraine and 15 per cent in Russia this year. Russian inflation could hit 28 per cent for the year. More

Sweden’s central bank performed a dramatic U-turn on Thursday as it raised interest rates, said it would shrink its balance sheet and warned of more increases to come as it belatedly responded to surging inflation.The Riksbank reversed the stance it had adopted at its previous meeting in February, when it said it would only lift interest rates from zero towards the end of 2024. On Thursday, the bank raised its main repurchase rate to 0.25 per cent and forecast that rates were likely to reach 1 per cent by the end of the year.Sweden’s central bank has been surprised by the strength of inflation, but it forecast prices would increase 5.5 per cent this year, well above its previous forecast of 2.9 per cent and its target of 2 per cent.“Inflation has risen to the highest level since the 1990s and will be high for some time. To counteract the high inflation from becoming entrenched in price and wage-setting, the executive board has decided to raise the repo rate,” the Riksbank said in a statement.The central bank has long struggled with its inflation mandate, raising rates in 2010 only to have to cut them to below zero afterwards, a move often cited as a cautionary tale against monetary tightening by the US Federal Reserve. It then followed with a five-year experiment with negative rates, ending only in December 2019 after parts of the financial industry complained that it was hitting profits.Coming out of the Covid-19 pandemic and with the addition of energy and food price shocks from Russia’s invasion of Ukraine, the Riksbank stood out with its call in February to keep rates at zero for years to come even as other central banks tightened policy. It has now joined the global consensus in tightening policy to counteract rising inflation.

The Swedish central bank warned that it was “more uncertain than usual” about how inflation would behave in the coming months and added that “the risk outlook . . . is on the upside”, meaning rates could be higher than forecast.“The Riksbank finally bowed to economic logic . . . and today’s announcement completes a remarkable U-turn from the bank’s thus-far decidedly dovish stance,” said David Oxley, senior Europe economist at Capital Economics.The Riksbank also said that it would slow the pace of its asset purchases in the second half of the year, meaning its balance sheet would start to shrink. It will buy SKr37bn ($3.6bn) of bonds in the second half of the year, half the level of the first six months.Sweden’s growth is expected to slow considerably at the same time that inflation rises, with gross domestic product now forecast at 2.8 per cent for this year and 1.4 per cent for 2023, both lower than February’s forecasts of 3.6 and 2 per cent, respectively. More

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Volvo Cars has begun sourcing alternatives to its Chinese-made parts as coronavirus lockdowns now spreading across the country add a new supply chain threat to an auto industry that has been beset by them over the past year. The company started double sourcing components that are obtained in China in a bid to shield its operations from potential disruption, according to chief executive Jim Rowan.“The longer the pandemic stretches the more uncertainty there is. We have already implemented a strategy of ‘make where we sell’ and ‘source where we make’,” he said.“We have already started a programme some months ago to source more components out of China so that we’re double sourcing, but that doesn’t happen overnight,” he added.Carmakers typically purchase parts from a single provider, which they ship to factories under a “just-in-time” model that reduces the need to store components in warehouses. Although cheaper, it is a model that has left the industry particularly exposed to supply chain disruptions over the past year, notably because of a shortage of semiconductors and, more recently, Russia’s invasion of Ukraine.Volvo’s effort to insulate its supply chain came as it reported that first-quarter sales dropped 20 per cent to 148,000 because of a shortage of chips. Revenues, however, rose 8 per cent to SKr74.3bn (£6bn) because of stronger pricing and income from Polestar, the electric brand that Volvo jointly owns with Geely.The chip shortage also led to problems sourcing one particular component that will affect production until the summer, Volvo added, as it reported that net income dropped 30 per cent to SKr4.5bn. The industry expects the chip situation to ease in the second half of the year. The manufacturer said that roughly 8 per cent of its models in the first quarter were fully electric, despite the group trying to prioritise battery cars with the chips it is able to source.“Underlying demand for our BEV [battery electric vehicle] products is incredibly high, if we had supply it would be even higher,” said Rowan.The marque wants to produce only electric cars by the end of the decade, and Rowan said he expected volumes to increase as infrastructure was rolled out and Volvo launched new battery models.One in three cars sold in the quarter was hybrid or electric, while the level hit 100 per cent in some markets including Norway, Brazil and Thailand. More

Boris Johnson’s tough new stance on the post-Brexit status of Northern Ireland has set off alarm bells in the Treasury, where officials fear it could provoke the EU into starting a trade war that would worsen the cost of living crisis.The prime minister has been secretly drawing up legislation that would give ministers sweeping powers to tear up the Northern Ireland protocol, the post-Brexit deal governing trade in Northern Ireland.But senior officials have told the Financial Times that the move has worried the Treasury, which fears that if Johnson used the powers it could lead to a damaging retaliation from Brussels.“If you have a trade war, that will have an impact on the economy, especially when you have an actual war going on in Europe,” said one. Another official confirmed the policy was causing concern at the Treasury.Johnson told ministers this week to come up with ways to cut the cost of living, but Treasury officials fear a trade war would push up prices further.So far chancellor Rishi Sunak has not been involved in the detail of the policy, drawn up in conditions of secrecy by Johnson with foreign secretary Liz Truss and Northern Ireland secretary Brandon Lewis.Johnson has confirmed he is prepared to legislate to allow ministers to revoke parts of the protocol, which keeps Northern Ireland in the EU single market for goods, thereby creating a trade border in the Irish Sea.The proposed Northern Ireland bill, whose existence was disclosed by the FT this month, has yet to be approved by the cabinet. Last year Sunak warned about the economic risks of unilaterally scrapping parts of the protocol.Johnson told MPs on Wednesday: “There is clearly an economic cost to the protocol. That is also now turning into a political problem.” The pro-UK Democratic Unionist party opposes the protocol and the border in the Irish Sea. The region is holding elections on May 5.Last autumn the EU discussed possible retaliatory measures as Johnson flirted with the idea of suspending parts of the protocol. Since then Emmanuel Macron, who takes the hardest line on the issue, has been re-elected as president of France.Many diplomats are furious with Johnson for raising the dispute when the west is struggling to maintain unity on sanctions on Moscow. “We are sick of hearing of Boris’s emotional difficulties [with the EU],” said one diplomat. “There are bigger things to worry about.”

However European diplomats insisted this week that the EU will not be provoked into a trade war with the UK, and that the bloc would be patient. They did not want a fight with Johnson that would boost his popularity with pro-Brexit Conservative MPs.“We don’t want to become part of a Tory leadership contest,” said one diplomat, referring to the possibility that Johnson could be challenged by his own MPs.The diplomat noted that any legislation would be opposed in the House of Lords and it could be months before the UK could use it. “We don’t want to make life impossible for a future Tory leader,” he added.“Why should we react?” said one official, adding that the plan was to hope Johnson was ousted and the bloc could build a more pragmatic relationship with his successor.Another senior official said the Ukraine crisis was absorbing all the EU’s time and attention. “Those conversations [about retaliation] have not happened. Nobody is focused on the UK. Since February 24 the only big thing on our plate has been Ukraine and Russia.”EU countries are wary of inflicting further pain on their own companies and consumers already struggling with rising prices partly caused by Russia’s invasion of Ukraine.They are also relying on the US to restrain Johnson. Washington reacted to the FT’s report on the UK’s plans to legislate by reiterating the importance of the Northern Ireland protocol to peace on the island. Lord David Frost, former Brexit secretary who negotiated the protocol, said on Wednesday that it would be “entirely reasonable” for the government to act unilaterally to override elements of the deal in domestic law.He said the protocol was not intended to be “a permanent feature” of Britain’s relationship with the EU. “It would be entirely wrong and unwarranted to draw any conclusions about our wider attitude to international law,” he said, in a speech at the Policy Exchange think-tank.

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