Economy

The writer is a senior fellow at Harvard Kennedy School and chief economist at KrollThe last time the European Central Bank raised interest rates, in 2011, then president Jean-Claude Trichet cited “sharp increases in energy and food prices”. The economy tanked, and the rate rises were quickly reversed. Now, food and energy prices are soaring again. This month, ECB president Christine Lagarde refused to rule out rate increases in 2022, and hawkish members of the governing council have urged quicker tightening. They risk repeating Trichet’s mistake. Eurozone inflation has exceeded the ECB’s target of 2 per cent since the middle of last year, accelerating to 5.1 per cent in January, the highest in more than 20 years. Inflation was forecast to slow as Germany’s 2020 value added tax cut and new CO2 tax dropped out of the annual comparison. This was a surprise, and Lagarde is right to be concerned. The problem is there’s not much she and her colleagues can or should do about it. The main driver of higher prices is energy, which accounts for just over half the headline reading. Gas prices rose nearly fourfold from June to December 2021 and jumped again this week as Russia moved into Ukraine. Roughly 40 per cent of Europe’s natural gas is imported from Russia. If Russia decides to turn off the energy taps in retaliation for sanctions, energy costs will rise further. Food prices have also lifted overall inflation. Strip out these factors, though, and core inflation fell to a 2.3 per cent annual rate in January from 2.6 per cent in December. Even with the threat from Russia, European natural gas futures forecast prices will fall in 2023. Brent oil futures, meanwhile, suggest prices will drop from nearly $100 a barrel to $86 a barrel by the end of the year. If the futures markets are right, higher energy costs are transitory and the ECB should look through them. If wrong, elevated energy prices would weaken demand — hardly an environment in which the ECB should tighten policy. Inflation in the eurozone has also been pushed up by supply chain disruptions. There are tentative signs these have been easing. According to Markit’s purchasing managers’ index, manufacturing suppliers’ delivery times continued to shorten in January. Sanctions on Russia could bring new interruptions, but again, that would portend slower growth, another constraint on tighter credit. Sustained wage growth could justify ECB rate rises this year. But so far there is little evidence of this. The labour market has tightened, with unemployment at historically low levels. While employment has recovered to pre-pandemic levels, there remains a significant shortfall in hours worked because of short-term working schemes. Serious wage pressures are only likely to appear once short-term workers are reabsorbed and people start working overtime. Negotiated pay deals play a significant role in eurozone wage growth, covering roughly two-thirds of the workforce and spanning multiple years. Unions, however, have been more focused on protecting employment and seeking benefits and flexibility than pay rises during the pandemic. HSBC research shows wage growth in pay deals dropped to an all-time low of 1.4 per cent year on year in the third quarter of 2021. This is well below 3 per cent, the level identified by ECB chief economist Philip Lane as consistent with the ECB’s 2 per cent inflation target. Hefty minimum wage increases in Germany and Spain will contribute to pay growth for workers up the wage scale, but they are a one-off measure and so won’t lead to a wage-price spiral. Finally, unlike the US, growth in the eurozone is weak. The Bundesbank recently forecast Germany will fall into recession in the first quarter. Eurozone gross domestic product remains below the pre-pandemic trend. High energy costs and Covid restrictions have dragged on consumption, and supply shortages weigh on industrial production. We should see a rebound in the second and third quarters as restrictions are dropped and new Covid cases subside, but it will be tempered by the income shock of higher inflation and energy costs. Aggressive rate estimates for the ECB now have the deposit rate rising 50 basis points to zero per cent by the end of the year. Spreads between peripheral bond yields and German Bunds have crept up in response. The ECB must move slowly and avoid being led by the markets. Raising the policy rate won’t alleviate oil or gas supplies and premature withdrawal of accommodation could kill the recovery and reintroduce fragmentation concerns. Those who do not learn from history risk repeating it. More

LONDON (Reuters) – Emerging market borrowing led by China inflated the global debt mountain to a record $303 trillion in 2021, although the global debt-to-GDP ratio improved as developed economies rebounded, the Institute of International Finance said on Wednesday. The $10 trillion rise in the global debt pile was down from the $33 trillion increase in 2020 when COVID-19-related expenditure soared. Global debt-to-GDP – https://fingfx.thomsonreuters.com/gfx/mkt/akvezxgblpr/bis%20chart%20one.PNG But more than 80% of last year’s new debt burden came from emerging markets, where total debt is approaching $100 trillion, the IIF said in its annual global debt monitor report.That means emerging markets have started 2022 facing record high refinancing needs just as the Federal Reserve prepares to raise interest rates after years of record low borrowing costs.”While the pace of accumulation slowed in 2021, EM government debt levels remain elevated,” the IIF authors wrote.”This slowdown is in line with the moderation in government budget deficits seen over the past year. Yet, since the onset of the pandemic, some EM governments seem more reliant on off-budget borrowing,” they said, pointing to rising non-financial corporate debt levels in China, Russia and Saudi Arabia.Most of the jump in individual country debt-to-GDP ratios occurred in emerging markets. Emerging market debt ratios surge – https://fingfx.thomsonreuters.com/gfx/mkt/gdpzybrznvw/BIS%20chart%20two.PNG The IIF also noted that the vast majority of additional emerging market debt last year was in local currencies, and its share the highest since 2003. This came at a time when the pandemic slashed foreign investors’ appetite for local currency assets — at 18%, foreign participation in local bond markets is at its lowest since 2009. Emerging markets rely on local currency debt – https://fingfx.thomsonreuters.com/gfx/mkt/byvrjeogwve/BIS%20chart%20three.PNG Those countries heavily reliant on external borrowing face greater risks from wobbly market sentiment and the rise in U.S. interest rates. Global indebtedness soared during 2020 as governments spent huge sums to revive their economies, bail out businesses and keep their citizens employed. While global debt levels remain very high by historical standards, economic recoveries and higher inflation helped improve the picture slightly last year.The global debt-to-GDP ratio fell to 351% in 2021 from an all-time high of more than 360% in 2020, although last year’s rate is some 28 percentage points above pre-pandemic levels.Issuance of debt carrying an environmental, social and governance label boomed as investors piled into sustainable debt markets.ESG-labelled issuance topped a record $1.4 trillion, nearly double the pace of 2020, although at around $3.4 trillion the ESG debt universe accounts for just 1% of global debt, IIF said.Demand for ESG products is expected to increase that share. The IIF sees total global ESG debt issuance reaching $1.8 trillion in 2022 and potentially $7.2 trillion by 2025. Global ESG-labelled debt issuance – https://fingfx.thomsonreuters.com/gfx/mkt/znvnendylpl/BIS%20chart%20four.PNG More

LONDON (Reuters) – Bank of England policymaker Silvana Tenreyro said on Wednesday that she – like other BoE policymakers – saw a case for higher interest rates to tackle inflation near a 30-year high, but the extent of tightening needed was uncertain.Financial markets currently price in BoE interest rates reaching nearly 2% by the end of this year, but central bank forecasts at the start of the month showed inflation would undershoot its target if rates reached 1.4%.Tenreyro, in a speech to be delivered to the National Institute of Economic and Social Research (NIESR), noted that inflation was forecast to fall almost back to target without raising rates above their current 0.5%, and that rates had only been 0.75% before the pandemic.”This metric would also suggest only a small amount of policy tightening will ultimately be required, reflecting the small share of the overall stimulus in the pandemic provided by monetary policy in the UK,” Tenreyro said.Government fiscal policy had been the main source of support for Britain’s economy during the pandemic, she said.Tenreyro voted against the BoE’s rate rise in December, its first since the start of the pandemic, saying she preferred to wait a few weeks for clarity on the impact of the rapidly spreading Omicron variant of coronavirus.In February she joined the majority in voting to raise rates to 0.5% from 0.25%.”The outlook and the risks had shifted in favour of a more front-loaded tightening,” she said. “With the inflation pick-up from higher tradeable goods price inflation now set to be larger and likely more persistent than previously expected, I thought an earlier tightening would strike a better balance between inflation and output volatility,” she added. More

MOSCOW (Reuters) – The Russian rouble weakened on Wednesday, reversing gains made the previous day and heading back towards 80 to the dollar as investors took stock of Western sanctions imposed on Russia for ordering troops into separatist regions of eastern Ukraine. The United States, the European Union, Britain, Australia, Canada and Japan responded to President Vladimir Putin’s recognition of separatist enclaves in the Donbass region of eastern Ukraine with plans to target banks and elites while Germany froze a major gas pipeline project from Russia.British Foreign Secretary Liz Truss, announcing more measures on Wednesday, said Britain would stop Russia selling sovereign debt in London.By 1045 GMT, the rouble was 0.9% weaker against the dollar at 79.51 and had lost 0.9% to trade at 90.23 against the euro.Russia was celebrating the Defender of the Fatherland public holiday on Wednesday, with many traders away from their desks, but some trading went on. The initial round of new sanctions stopped short of targeting major financial institutions, meaning their impact could be rather symbolic.The United States broadened restrictions on trading of Russian government debt, prohibiting participation in the secondary market for bonds issued after March 1, a move that analysts said might have a moderate impact near-term but could be a step towards a harsher measure.Russia’s finance ministry on Wednesday said it would offer only new series of OFZ government bonds from now on, in response to Washington’s move.Russian dollar bonds extended their losses, with longer-dated issues dropping more than 4 cents to trade in their low 90s, Tradeweb data showed. Some of Ukraine’s dollar bonds fared even worse with the 2032 issue dropping 5.5 cents to trade at 66.37 cents in the dollar.The premium demanded by investors to hold Russian and Ukrainian debt over safe-have U.S. Treasuries also widened sharply to 391 basis points and 1280 bps respectively – both at their widest level since 2015Brent crude oil, a global benchmark for Russia’s main export, was down 0.5% at $96.41 a barrel.Russia’s dollar-denominated RTS index was down 0.4% to 1,222.2 points. More

The IMF said on Tuesday that Rishi Sunak should bring forward planned tax increases to limit the risk of persistently high inflation, even though it would tighten the financial squeeze on Britain’s households.In its annual assessment of the UK economy, the fund said the chancellor should spare poorer households and impose higher income and wealth taxes on richer people. The advice would help prevent the need for tougher action in the months ahead to bring down inflation, it said. The fund’s gloomy assessment comes as the UK economy faces a rise in inflation to 7 per cent in the coming months, with households facing their biggest squeeze on living standards for 30 years.The fund added that in the short term the Bank of England should not increase interest rates rapidly or it could risk tipping the economy into recession. With inflation forecast by the fund and the BoE to hit 7 per cent in April, when the government’s energy price cap rises 54 per cent, the IMF said the central bank should be “steadily adjust[ing interest rates] towards a neutral setting”, which it said was between 1 per cent and 1.5 per cent.But even with a tightening of monetary policy of this amount, the risk was that inflation would remain too high for too long and become ingrained into UK price setting and wage demands, the IMF said. It said indicators of wage settlements, corporate pricing intentions, survey and market-implied inflation expectations all “flashed red at present” but added that the BoE had a difficult task in balancing the risk of snuffing out the recovery if it raised rates too quickly and letting high inflation become embedded in UK life. “At present, the data suggest that the latter risk is of greater concern,” the IMF staff concluded. Giving evidence to the Treasury select committee of the House of Commons, Andrew Bailey, governor of the BoE, took a similar position on the threats of persistently high inflation. He said there was “very clearly” a risk that high price rises and high wage increases could continue. After facing criticism for telling people not to ask for high wage increases, Bailey said: “It’s not just wage setting, it’s also price setting . . . it’s both. There is very clearly an upside risk there. The upside risk . . . comes through from the second-round effects.”With this fear and the balancing act faced by the BoE, the fund staff said Sunak could help bring inflation under control with earlier than planned tax increases.

“The authorities could bring forward some fiscal tightening from 2023-24 to 2022-23 to help contain demand in the short run with the benefit of also reducing the drag on growth in outer years”, while using contingency funds to help the poorest, the IMF concluded. But it added that this should be dropped if a new virulent coronavirus wave hit the economy, with the government again implementing the exceptional support offered during the pandemic. The recommendation of what the IMF staff called a “rotation” from monetary to fiscal tightening to contain inflation was controversial when it was put to the IMF board earlier this month. Shona Riach, the UK’s lead official on the IMF board, ignored the recommendation to bring forward tax increases in her formal response, while the account of the board meeting showed that “a few directors questioned the political feasibility of this suggestion”. More

LONDON (Reuters) – Bank of England Governor Andrew Bailey said on Wednesday a risk “very clearly” existed that inflation, which is running at a 30-year high, gets embedded in Britain’s economy if a cycle of higher prices keeps pushing up wages.”It’s not just wage setting, it’s also price setting … it’s both,” Bailey told lawmakers. “There is very clearly an upside risk there. The upside risk … comes through from the second-round effects.”Bailey said there were also risks that inflation comes in lower than the BoE’s forecasts over the next three years and he urged investors not to get carried away with bets on future interest rate hikes. The BoE became the world’s first major central bank to raise borrowing costs after the coronavirus pandemic in December and it pushed its benchmark Bank Rate up again this month to 0.5% from 0.25%.Four of its nine monetary policymakers voted for a bigger increase to 0.75%, which would have been the first half-point rise since BoE independence in 1997.British inflation hit its highest since 1992 in January at 5.5% and the BoE expects it to peak at about 7.25% in April when a 54% rise in regulated household energy tariffs takes effect.Bailey was asked by some members of parliament’s Treasury Committee to explain comments he made earlier this month about the need for constraint in pay deals, even with inflation running so high.One lawmaker, Angela Eagle from the opposition Labour Party, asked Bailey to state his pay which he said he could not remember precisely before confirming it was 575,538 pounds ($783,422) a year including his pension plan.INFLATION RISKSBailey said inflation would accelerate if everyone tried to get pay rises that exceeded inflation, and that the losers would be the workers with the weakest pay-bargaining power.Investors are fully pricing in another 25 basis-point rate hike at the BoE’s next scheduled meeting which concludes on March 17, followed by another in May, and see rates at nearly 2% by the end of this year.Bailey said the BoE top monetary policymakers did not have a big disagreement on the level that Bank Rate needed to reach eventually, even if they were divided this month about the pace of the increases.”It’s important not to put too much emphasis on … whether we took a different view on the level that we expected to get to, as opposed to the pace by which we get there,” he said.Silvana Tenreyro, an external member of the BoE’s Monetary Policy Committee, said that the BoE’s forecasts showed inflation in three years’ time would be only just above its 2% target if rates did not rise at all, implying that only “really modest” tightening was needed. MPC member Jonathan Haskel, who was part of the minority that voted for a rise in Bank Rate to 0.75%, said it was “a very, very finely balanced decision”.Deputy Governor Ben Broadbent said the surge in energy prices – which has been the inflation rate’s biggest driver – was likely to be twice as big in 2022 than in any year in the 1970s, when high inflation plagued many economies.”This is the most challenging period for monetary policy since inflation targeting began in 1992,” Broadbent said in an annual report to the Treasury Committee.($1 = 0.7346 pounds) More

LONDON (Reuters) -London’s Heathrow airport, Britain’s busiest, saw its lowest number of passengers since 1972 last year and suffered wider losses as the coronavirus pandemic slashed demand for business travel and holidays.Passenger numbers fell to 19.4 million in 2021. Heathrow also recorded a pretax loss of 1.79 billion pounds ($2.43 billion) for 2021, taking total loses during the pandemic to 3.8 billion pounds due to the drop in passengers and high fixed costs.Chief Executive John Holland-Kaye said Heathrow expected to meet its target of more than doubling passengers to 45.5 million this year, although demand would be “quite peaky” and focused on British school holidays. Passenger numbers were currently 23% behind forecast, but he said there were signs of recovery, with the airport seeing some of its busiest days in two years as families went skiing during the school break last week.”Summer in particular we think will be quite busy,” he said in an interview. “After two years of staycations, people want to get some guaranteed sunshine.”He said Heathrow was working with airlines to scale-up its operations and reopen Terminal 4 for the summer peak.But while outbound tourism had been boosted by the removal of restrictions in Britain, Holland-Kaye said inbound tourism and business travel remained suppressed, including transatlantic routes, because of testing requirements in other countries.He said he did not expect travel to return to pre-pandemic levels until all restrictions had been removed and passengers were confident they would not be reimposed.Heathrow is awaiting the aviation regulator’s final proposals on what it can charge passengers for the 2022-2027 period, after it criticised the airport’s plan to raise charges by nearly half. Airlines have also voiced their opposition.Holland-Kaye said if the regulator did not rectify “major mistakes” in its initial proposals, there could be a return to the “Heathrow hassle” of 15 years ago.”If we get it right, we can continue to have the seamless journeys that people have been used to, and the price for doing that is less than 2% on the ticket price,” he said.($1 = 0.7359 pounds) More

GOVERNOR ANDREW BAILEY ON INFLATION UNCERTAINTY”It’s not just wage setting, it’s also price setting…it’s both. There is very clearly an upside risk there. The upside risk…comes through from the second-round effects.””The second-round effects are a real concern. If we get the second-round effects… of course we would need to react to that with higher interest rates… And the consequence of that, I have to point out, and I know I’m unpopular for saying these things, is that it would of course slow activity in the economy and it would increase unemployment”BAILEY ON HIS CALL FOR RESTRAINT WITH PAY RISES”I’m not saying people should not take pay rises. I did make the point earlier it was in the context of large pay rises.My concern is the second-round effects. If everybody tries to get ahead of the shock that we’ve had from outside…then we’ll get the second-round effects and it will get worse.” BAILEY ON MPC’S DIFFERENT VIEWS ON RATES”It’s important not to put too much emphasis on…whether we took a different view on the level that we expected to get to as opposed to the pace by which we get there.”MPC MEMBER JONATHAN HASKEL ON HIS VOTE FOR 0.75% BANK RATE”I have to stress it’s a very uncertain situation and it’s a very, very finely balanced decision.” More