For something so long discussed and anticipated, the Federal Reserve’s quarter-point rate rise, the first since 2018, caused remarkably little stir when it finally arrived on Wednesday. The central bank, long the most important player in financial markets, had to compete with Russia’s invasion of Ukraine and a new wave of coronavirus infections in China as a topic for discussion. The lack of reaction is testament to how Jay Powell, Fed chair, had prepared markets for the gradual tightening of monetary policy since the central bank changed its tone last September.
Moderation in monetary tightening is justified, at least during wartime. There was no need to add another shock to markets that are following the conflict in Ukraine as well as the impact of locking down large parts of China which is already, on some measures, the world’s largest economy. Energy traders are already considering asking central bankers for emergency support as the disruption to their markets risks causing a liquidity crisis.
There was a case for going further. The data has indicated for a while that inflationary pressure in the US is broadening from pandemic-related bottlenecks and surges in global energy prices to domestic services. Indeed, the Fed, in its messaging, struck a hawkish tone and members of its rate-setting committee indicated they expect six further rate rises this year. While there are disagreements about the speed and eventual endpoint of the tightening cycle there is consensus that the US no longer needs the stimulus launched at the start of the pandemic.
There are risks on both sides to the Fed’s outlook — not least the progress of the war in Ukraine. Any ceasefire or even a lasting peace deal would be disinflationary — partly reversing the increase in oil prices since the invasion began — while escalations of the violence could exacerbate the stagflationary pressure in the world economy. China’s Covid lockdowns, too, could have unforeseen effects, reducing global demand for commodities but also aggravating the problems with supply chains that have driven up prices for some manufactured goods.
The Fed’s recent forecasts are notable for the central bank’s apparent belief that it can painlessly reduce inflation. The central bank predicts that the unemployment rate will fall further to 3.5 per cent and then remain there, even as rates rise from the current 0.5 per cent to an expected 2.8 per cent by 2023. Powell has previously expressed admiration for his predecessor Paul Volcker’s choices in the late 1970s to raise rates aggressively even in the face of mass joblessness; the latest forecasts deny such trade-offs even exist.
The Bank of England, which raised rates for the third consecutive time on Thursday, struck a far more cautious note. While at its previous meeting four members of the monetary policy committee dissented and argued for faster rate rises, at this one there was only one dissenter, who said the BoE should hold fast. The MPC argued that Russia’s invasion would, in the short term, increase the rate of inflation at its peak but over a longer period damp economic activity, bringing inflation down more swiftly than the committee had first anticipated.
The outlook is murky but the Fed certainly appears too optimistic. It is not clear whether it is overconfident about its ability to control the inflationary pressure that has built up over the past year — pressure that it has consistently underestimated — or to limit the slowdown in the US economy and knock-on effects on unemployment from the oil shock. The rest of us can only hope whatever mistake they make it is not too large.
Source: Financial Times