Economy

The world economy is racked by inflation and struggling with growth. But the situation is perhaps best summed up by one datapoint: the number and variety of policy changes announced by central banks around the world this week. The Federal Reserve made the punchiest move. Its officials now expect core inflation — a measure that excludes the most volatile items — to settle at 4.3 per cent this year. This is a key part of why it delivered on Wednesday a 0.75 percentage point rise in interest rates; the biggest in almost 30 years. At the same time, it is starting to scale down its asset holdings — another form of tightening. The Fed wants people to see that it still has an inner Paul Volcker.The 1980s Fed chair put the US economy through the wringer of extremely tight monetary policy to end the inflationary legacy of the 1970s. Current chair Jay Powell and his colleagues this week presented projections showing they are willing to slow the economy and raise joblessness. He sounded glum about the prospect of a “soft landing”.But for all the downgrading of forecasts, it is important to keep the Fed’s doom in context. Its rate-setters are still forecasting a reasonably benign scenario. They think growth will continue and the most pessimistic forecast is for unemployment at 4.5 per cent. The Bank of England would do anything for such a happy outcome. This week it raised rates by just 0.25 percentage points, even though inflation is expected to hit 11 per cent. But the BoE expects economic stagnation anyway, so does not need to tap the brakes as firmly as the Fed.The European Central Bank, meanwhile, is reliving chapters from its eurozone crisis history books. Investors are jitterier about high-debt eurozone governments, leading to some states in the monetary union suddenly facing higher borrowing costs. The ECB called an emergency meeting to announce measures to deal with this “fragmentation”, and hold the financial system of its caravan of countries together. This has all been hard for investors to follow. Global stocks overall are down on fears of higher borrowing costs and recession, though there were some glimmers. The Fed decision actually led to a rise in share prices, with the S&P 500 up by 1.5 per cent on Wednesday, largely because Powell said the Fed might make smaller increases in future. But it fell by twice as much on Thursday thanks to an unexpected rate rise by the Swiss central bank. The big picture running through these decisions is that stagnation looks more likely than it did last week. This was a week of sudden moves by central bankers — and after a long period when they could fairly be criticised for being too slow. The changes this week should nonetheless be welcomed. This is, fundamentally, a hard time to do the job. The war in Ukraine continues to drive inflation while weighing on growth. Covid-related lockdowns in China may continue having an effect on supply chains. The world economy is facing fast-moving supply pressures, and central bankers are stuck with a slow-moving demand-side toolbox. Furthermore, uncertainty is unusually high. No one has a grip on how strong these unique inflationary pressures will be, nor the effect on growth, trade, jobs and incomes. This week’s sudden lurches by central banks came in response to genuinely new economic information: higher-than-expected consumer prices, some fast-rising eurozone bond yields and a jump in US inflation expectations. Economic policymakers’ strategies ought to be data-dependent, not dogmatic. And that means, at a moment when the data keeps moving, so will their policies. Expect turmoil ahead. More

The author is professor emeritus at the Stern School of Business, NYU and chief economist at Atlas Capital TeamFaultlines in the eurozone are resurfacing. In response to a sharp widening of sovereign bond yield spreads in Italy and other states, the European Central Bank held an emergency meeting on Wednesday. Its governing council decided to work on designing a new facility to address “fragmentation risk”, or the idea that the effect of monetary policy on the 19 nations in the eurozone may vary widely, with potentially destabilising consequences.The dangers are real. Italian long-term yields have surged from below 1 per cent at the start of the year to above 4 per cent in recent days. But fragmentation risk is not the only serious problem for the ECB. In recent months, inflation in the eurozone has also surged above 8 per cent. This is at a similar level to the US, but, unlike the Federal Reserve, the ECB plans to wait until next month to start raising interest rates. This lag behind the Fed and other central banks is due to a variety of reasons. There is more slack in labour and goods markets in the eurozone than the US as the area’s recovery from Covid-19 has been more sluggish.Supply shocks, including soaring energy prices and those of other commodities following the Russian invasion of Ukraine, are a greater factor than excessive aggregate demand in driving eurozone inflation. Wage growth is more modest than in the US, and the rise in core inflation is smaller.Supply shocks that reduce growth and push up inflation present all central banks with a dilemma. To prevent inflation expectations from getting out of control, they should normalise monetary policy sooner and faster. But that risks a hard landing of the economy, with recession and rising unemployment. If, on the other hand, the banks also care about economic growth and jobs — as even the ECB does, in spite of its single mandate of price stability — they may normalise more slowly and risk de-anchoring inflation from its expectations.The US and the UK are currently at serious risk of a hard landing as the Fed and Bank of England aggressively tighten rates. But this risk is at least as large, and most likely greater, in the eurozone than in the US. The recovery from Covid has been more anaemic in the region. It is more exposed to energy shocks from a long war in Ukraine. And given its reliance on exports to China, it is also more vulnerable to a slowdown of Chinese growth stemming from Beijing’s zero-Covid policy.Moreover, the weakening of the euro that arises from the difference in ECB and Fed monetary policies is inflationary. The increase in borrowing costs for the eurozone periphery is larger. Some forward-looking indicators, such as German manufacturing data, signal that the area may be heading for a recession even before the ECB starts raising rates. All of this is happening as ECB hawks, keen to raise rates sooner and faster, are gaining the upper hand in the governing council. The eurozone suffers from weak potential growth and job creation. A hard landing would not only exacerbate these problems but intensify market concerns about debt sustainability, or fragmentation risk. The “doom loop” between indebted governments and banks holding that debt, a feature seared into the minds of many by the eurozone crisis a decade ago, would come back into focus.Designing a new facility to deal with fragmentation risk is easier said than done. ECB doctrine argues that potentially unlimited purchases of some governments’ bonds are acceptable only if widening yield spreads are driven by unwarranted market dynamics. When poor policies rather than bad luck are the driver, ECB bond purchases need to come with conditions attached. This is how the Outright Monetary Transactions facility was designed in 2012 but no government requested it because none wanted to accept the politically fraught conditions. Still, in order to pass legal muster, any new facility will need to include something along these lines.The recent widening in Italian and other spreads is not just driven by irrational investor panic. Italy has low potential growth, large fiscal deficits and a huge, possibly unsustainable public debt that has grown during the pandemic. Now a permanent rise in debt servicing costs looms as the ECB withdraws its ultra-accommodative policies. The risk of a “doom loop” is higher in Italy than in the rest of the eurozone.Next year’s Italian elections may produce a rightwing coalition dominated by parties bristling with scepticism about the euro and the EU. In practice, any new ECB facility designed to rescue Italian bonds may come with conditions unacceptable to the country’s new leaders — and to any other eurozone states under pressure.Before this week’s ECB meeting, executive board member Isabel Schnabel stated that the bank’s willingness to deal with fragmentation risk had “no limits”. This echoed former ECB president Mario Draghi’s game-changing “whatever it takes” statement of 2012. But Schnabel also hinted at the need for policy conditionality when it comes to offering support. Given the current volatility of financial markets, one can expect they will further test the ECB’s ability to protect the currency union by backstopping fragile eurozone states.  More

A top Federal Reserve official said the US central bank’s decision to raise its benchmark policy rate by three-quarters of a percentage point this week risked adding to “policy uncertainty” in a statement explaining her decision to oppose the move.Esther George, president of the Fed’s Kansas City branch and typically one of the most hawkish voting members of the policy-setting Federal Open Market Committee, was the lone dissenter on Wednesday to the biggest rate rise since 1994, which lifted the federal funds rate to a new target range of 1.50 per cent to 1.75 per cent. She instead voted in favour of the Fed sticking with its previously telegraphed half-point increase. Before the scheduled “blackout” period ahead of the policy meeting — during which policymakers’ public communications are limited — officials had explicitly backed another half-point rate rise, having delivered the first since 2000 in May. But two alarming inflation reports released last week that not only indicated price pressures were mounting but also at risk of getting worse, prompted officials to rethink that pace, resulting in the larger-than-expected adjustment.In a statement released on Friday, George said she “viewed that move as adding to policy uncertainty simultaneous with the start of balance sheet run-off”. In addition to raising interest rates, the Fed is also shrinking its $9tn balance sheet, a process that officially got under way on Wednesday.“The speed with which we adjust the policy rate is important,” George said. “Policy changes affect the economy with a lag, and significant and abrupt changes can be unsettling to households and small businesses as they make necessary adjustments.”She added that it had knock-on effects for US government bond markets and broader borrowing costs, but affirmed the case for tighter monetary policy was “clear-cut”.Beyond implementing a jumbo-sized rate rise, the Fed also set forward an aggressive plan to tighten monetary policy this year and next in a bid to quell the worst inflation problem in four decades. Most officials now project rates will rise to 3.4 per cent by the end of 2022, a level chair Jay Powell said was expected to be “modestly restrictive” on economic activity. Powell said he does not expect 0.75 percentage point moves to be “common”, but did say another was possible in July. He also said the Fed would look for a string of decelerating monthly inflation prints as it determines how aggressive it needs to continue being. Neel Kashkari, the dovish president of the Minneapolis Fed, said on Friday that a move of that magnitude may be warranted in July, but warned about the risks of overdoing it. “This uncertainty about how much tightening will be needed leads me to be cautious about too much more front-loading,” he said in remarks published on the bank’s website. Kashkari said a “prudent strategy” may be continuing with half-point rate rises after the July meeting “until inflation is well on its way down to 2 per cent”.The Fed, in a monetary policy report released to Congress on Friday, said its “commitment to restoring price stability — which is necessary for sustaining a strong labour market — is unconditional”.Officials see additional adjustments in 2023, with rates potentially rising to 3.8 per cent, and modest cuts the following year. Core inflation is set to fall as a result, with officials projecting it to settle at 2.7 per cent in 2023 and 2.3 per cent in 2024, from its 4.9 per cent level as of April. Reflecting that tighter monetary policy will probably dent the US labour market, policymakers pencilled in the unemployment rate rising to 4.1 per cent in 2024 from its current level of 3.6 per cent. The economy is still expected to expand, however, by 1.7 per cent this year and in 2023. Economists say these forecasts do not fully acknowledge the extent of the economic pain probably associated with what the Fed will need to deliver if it is to root out high inflation. Many now see the economy tipping into a recession next year, as the odds of a so-called “soft landing” plummet.“There is a path to a soft landing, but I think it’s very narrow, very hidden and will take a lot of luck to find,” said Roberto Perli, a former Fed staffer who is now head of global policy at Piper Sandler. More

Senior members of Boris Johnson’s government say a looming clash with public sector workers is one of the biggest risks to the UK’s economic and political stability, with anger over pay building towards a wave of industrial action.A nationwide walkout due to cripple rail services next week has been billed as the start of a “summer of discontent”. In the public sector, unions representing teachers, junior doctors, civil servants and local authority staff are moving towards strike action. Binmen and bus drivers are already on strike, while criminal barristers and postal workers are set to vote on action.Ministers fear that a confrontation over pay with public and quasi-public sector workers — who are suffering much bigger real terms wage cuts than their private sector counterparts — could either tip a faltering economy into recession or blow a hole in the government’s spending plans. One cabinet minister said the government was walking a “delicate tightrope” of keeping pay down and avoiding an inflationary wage spiral without forcing multiple sectors on strike: “If we get this wrong, we risk going into a de facto general strike that will create further turmoil that risks grinding the whole economy to a halt.”Another senior minister said the government “will have to hold the line, no matter how hard it gets” in pay negotiations, adding: “It’s going to be tough but we can’t go back to 8 or 10 per cent wage increases as we saw in the 1970s.”Economists say the direct impact of strike action on the economy will be limited. Despite parallels with the 1970s — when industrial unrest spread from coal miners to gravediggers — unions can no longer shut the economy down, with a much smaller membership concentrated in the public sector. But there is much at stake for public services and the public finances at a time when many Tory MPs want to prioritise tax cuts over extra spending. Wage deals for public sector workers lag far behind those on offer in the private sector, where many employers have been paying big bonuses to keep scarce staff. Official data shows average total pay growth for the private sector was 8 per cent in the three months to April, compared with 1.5 per cent in the public sector — one of the biggest gaps on record.The government has been trying to keep imminent pay settlements to just 2 per cent, or 3 per cent in some instances, arguing that going any further would set a benchmark for inflationary pay deals across the economy.Paul Johnson, director of the Institute for Fiscal Studies, said if the Treasury enforced this limit, as inflation nears double digits, it would double the real terms pay cut many public sector workers have already suffered since 2010. This would cause big problems for recruitment and retention, on top of the risk of strikes shutting down schools and hospitals.A pay rise that came anywhere near matching inflation would cost an extra £10bn. Because spending plans were set in cash terms, when inflation was expected to be much lower, departments will not be able to keep pace with rising prices without compromising the delivery of public services — unless the Treasury finds more money.“This is the biggest problem for the government this year, the most difficult decision,” Johnson, from the IFS, said.Although next week’s rail strikes will do less direct damage to the economy than past disputes — most goods are shipped by road and many commuters can work remotely — business leaders are acutely worried by the prime minister’s willingness to court confrontation.“We’re expecting the economy to be pretty much stagnant. It won’t take much to tip us into a recession . . . We’ve had weeks of politicking with the country standing on the brink of a summer of gridlock,” said Tony Danker, director-general of the CBI business, the employers’ organisation, which has called the rail strikes “particularly regrettable at a time when the economy is under such strain”.Neil Carberry, chief executive of the Recruitment & Employment Confederation, said that, with both employers and workers facing soaring costs, strikes could also become more frequent in the private sector: “In any unionised workplace there is going to be a higher risk of a dispute in the next year or two than there has been for a couple of decades.”Business groups add that their members are reporting a sharp pick-up in union activity, although private sector employers have often proved more willing to strike deals on pay before disputes reach the point of industrial action.Even where unions are not involved, workers are increasingly able to secure better terms and pay in a labour market with as many vacancies as there are people out of work. The Bank of England said on Thursday that companies were still struggling to hire, despite slowing economic growth, and were offering pay deals averaging just over 5 per cent, with a significant minority of companies considering mid-year top-ups as the cost of living rose.

Brian Reading — who served as economic adviser to prime minister Edward Heath in the run-up to the miners’ strike of 1972 — argued in a recent paper that the decline of trade unions would not stop workers securing inflationary wage deals at a time of widespread labour shortages.“Private sector unions are less aggressive today, but scarce skilled workers are more powerful,” he wrote. “Public sector workers have popular support . . . Cheap labour is no more.”  More

Federal Reserve Chairman Jerome Powell on Friday reiterated the central bank’s commitment to bringing down inflation.
In remarks to a conference on the U.S. dollar, he stressed that the Fed is “acutely focused on returning inflation to our 2 percent objective.”
Earlier this week, the Fed raised rates three-quarters of a percentage point in an effort to bring down surging inflation.

Federal Reserve Board Chairman Jerome Powell speaks to reporters after the Federal Reserve raised its target interest rate by three-quarters of a percentage point to stem a disruptive surge in inflation, during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, U.S., June 15, 2022.
Elizabeth Frantz | Reuters

Federal Reserve Chairman Jerome Powell reiterated the central bank’s commitment to bringing down inflation, saying Friday it’s essential for the global financial system.
“The Federal Reserve’s strong commitment to our price stability mandate contributes to the widespread confidence in the dollar as a store of value. To that end, my colleagues and I are acutely focused on returning inflation to our 2 percent objective,” Powell said in introductory remarks for a Fed-sponsored conference on the global role of the U.S. currency.

Those comments come two days after the Federal Open Market Committee voted to raise the benchmark interest rate by three-quarters of a percentage point to a targeted range of 1.5%-1.75%. Banks use the rate to set borrowing costs for short-term loans they provide to each other, but it also feeds through to a multitude of consumer products like credit cards, home equity loans and auto financing.
Inflation has been soaring over the past year, with the consumer price index in May posting an 8.6% increase over the past year.
Fed officials target 2% inflation as healthy for a growing economy and have said they will continue raising rates until prices return to that range.
While inflation hurts consumers through the prices they pay at the grocery store and gas pump as well as a multitude of other activities, Powell’s Friday remarks focused on its global financial importance.
“Meeting our dual mandate also depends on maintaining financial stability,” Powell said. “The Fed’s commitment to both our dual mandate and financial stability encourages the international community to hold and use dollars.”

In a addition to price stability, the Fed is charged with maintaining full employment.
Powell cited the importance of the dollar in global financing, noting in particular the significance of vehicles such as the one the Fed put in place during the Covid pandemic that loaned greenbacks to global central banks in need of liquidity.
He also noted coming changes to the global financial system, including the use of digital currencies and payments systems like FedNow, a service expected to come online in 2023.
A digital currency, as has been discussed by Fed officials, could help support the dollar as the world’s reserve currency, he said.
“Looking forward, rapid changes are taking place in the global monetary system that may affect the international role of the dollar in the future,” Powell added.

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At 1225 GMT, the rouble was 0.3% stronger against the dollar at 56.35 and was up 0.2% versus the euro at 58.90, reversing earlier losses.At Russia’s flagship annual economic forum in St. Petersburg, top Russian policymakers said the Russian economy was holding up better than expected in the face of unprecedented Western sanctions. But in a stark warning, the head of state-run Sberbank, the country’s largest lender and a bellwether for the wider economic, said Russia could take 10 years to return to its pre-sanction levels.Russian stock indexes also edged down in the first two hours of trading.The dollar-denominated RTS index shed 0.1% to 1,315.6 points. The rouble-based MOEX Russian index was 0.7% lower at 2,353.4 points.For Russian equities guide seeFor Russian treasury bonds see More

“Grateful to…(Canadian Deputy Prime Minister Chrystia Freeland) for support & comprehensive assistance to Ukraine in the fight against the aggressor,” Shmygal tweeted, referring to Russia which invaded Ukraine in February. The IMF set up the administered account in April to provide donors with a secure way to channel financial assistance to Ukraine in the form of grants and loans. Germany has also already pledged to contribute funds and other countries have expressed interest too, IMF spokesperson Gerry Rice said last week.($1 = 1.2985 Canadian dollars) More

Cryptocurrency valuations have plunged in recent weeks as investors dump risky assets in a rising rate environment, with bitcoin, which reached a record high of $69,000 in November, having lost more than half its value this year. “Recently, the crypto market has seen major fluctuations, and some institutions in the industry have experienced conductive risk events. Due to the current situation, Babel Finance is facing unusual liquidity pressures,” the company said.Crypto lenders gather crypto deposits from retail customers and re-invest them, proclaiming double-digit returns and attracting tens of billions of dollars in assets. However, the recent meltdown has lenders unable to redeem their clients’ assets.Babel, which has 500 clients and limits itself to bitcoin, ethereum and stablecoins, raised $80 million in a funding round last month, valuing it at $2 billion. It had ended last year with $3 billion of loan balances on its balance sheet.Earlier this week, U.S.-based retail crypto lending platform Celsius Network froze withdrawals and transfers between accounts “to stabilize liquidity” as the collapse of cryptocurrency TerraUSD in May triggered a rise in redemptions. More