WASHINGTON, Dec 7 (Reuters) – Thomas Barkin, Chairman of the Federal Reserve Bank of Richmond, was reviewing the latest inflation-related data one morning in June after having breakfast with bank interns when he saw an alarming sign . Prices had jumped in May, after a slight dip in April that had raised hopes that a recent rise in inflation would be short-lived.
Barkin said the data, which sparked a selloff in the U.S. bond market, prompted him in a call with Federal Reserve Chairman Jerome Powell to offer support for an interest rate hike. bigger than what the Fed had practically promised to announce a few days later. “Go as fast as you can without breaking things,” Barkin said in an interview last month of his message to Powell.
It was one of many conversations Powell had with Fed policymakers following the data, according to his public timeline for this Friday and Monday, as the world’s most powerful central banker sought to end to months of parading about the advisability of taking tougher measures to control inflation.
Within days, the Fed announced a bigger-than-expected hike of 75 basis points, its biggest step in nearly 30 years and what would be part of its largest interest rate hike since the 1980s. It was the signal for central banks around the world to join in a reversal of decades of cheap money policies that will impact the economic fortunes of people around the world.
Central bankers, who only a decade ago were celebrated for their role in rescuing the economy from the global financial crisis, now have their credibility on the line as they struggle to cope with inflation not seen in decades. decades.
From Washington to Frankfurt to Wellington, their mantra is that further rate hikes are needed even if – as Powell has publicly stated – it will mean “a bit of pain”. Higher borrowing costs weigh on owners and squeeze corporate margins.
And their work is expected to get tougher next year. The challenge: agreeing on the speed and distance to travel as the economic crisis worsens. Powell has already faced criticism from both sides of the US Congress; Monetary policy in Europe has been challenged by politicians including French President Emmanuel Macron, who has told central bankers to be “very careful”.
Powell, who declined to be interviewed for this story, has repeatedly said in public that he was keen to avoid the mistake central bankers made in the 1970s by moving too slowly, but also knew the credibility risk. to surprise the financial markets.
Prior to the price data released in June, Fed officials had expressed differing views on the temporary nature of the inflation spike and what action was needed. The new numbers showed how deep-rooted he was and that the little hikes he had done until then weren’t working.
Explaining the June rise, Powell told reporters afterwards that only once or twice in his decade-long career at the Fed had such groundbreaking data fallen so close to a rate decision. To those who say he was too slow to act, he admitted on several occasions with “hindsight” that he would have acted sooner.
EARLY WARNING SIGNS
After years of subdued inflation, Fed officials and other central bankers say they faced a chain of disruptive events beyond their control, from the COVID-19 pandemic to the war in Ukraine.
There was little precedent for how quickly things moved from an era of weak price growth to a point “where policymakers really had to apply themselves to bringing inflation down,” said Agustin Carstens, director of the Swiss-based Bank for International Settlements, known as the central bank for central banks.
In the United States, signs that inflation was taking on new proportions began to appear last year, ranging from labor shortages to supply shortages for a growing range of goods and services.
Richmond Fed’s Barkin told Reuters he had returned from a June 2021 visit to Charleston, South Carolina, intrigued by anecdotal evidence that many people were not returning to work. Parents, he said he noticed, were struggling to find child care.
David Altig, director of research at the Federal Reserve Bank of Atlanta, said the consensus view during this period that shortages of goods and services would gradually ease was not reflected in data and anecdotal evidence. .
“It just wasn’t happening,” Altig said.
The Federal Reserve has stuck to the idea that soaring inflation will subside as the pandemic-scarred economy returns to normal. “We continue to expect inflation to decline over the year,” Powell said in January, as the U.S. central bank continued to hold rates near zero.
The central bank began raising rates in March, but its officials remained split on how much it would take to raise them until consumer price data released in June put an end to the debate.
The hawks organize
The Fed’s shift to a more aggressive stance without spooking markets helped forge a majority for tougher action at the Frankfurt-based European Central Bank (ECB).
Earlier this summer, a group of political ‘hawks’ were pushing the ECB to commit to more than a token 25 basis point rate hike and emulate the Fed, according to more than a dozen officials with direct knowledge of the discussions.
Concerns that rate hikes could lead to an explosion in the borrowing costs of indebted eurozone states – particularly Italy – led in June to an agreement to help these countries with a so-called “debt instrument”. transmission protection” (TPI) which, if necessary, would be activated to support their debt.
“There was a shared consensus that by tackling tail risks, the TPI would also facilitate the start of an upside cycle,” ECB chief economist Philip Lane told Reuters. – among the “doves” who resisted a rapid tightening.
At an ECB meeting in July, the hawks – led by ECB board member Isabel Schnabel of Germany, Dutch central bank chief Klaas Knot and German Bundesbank chief Joachim Nagel – pushed for a bigger move than the 0.25% point reported to markets, according to conversations with the same dozen officials.
Those officials said the group, by coordinating meetings over the phone and in person, had sought to convince Lane that they now had a majority on the board set to set the rates for such a move. The ECB announced a 0.5% rate hike in July, followed by a 0.75% hike in September – its biggest move since 1999. Along with the Fed, another 75 basis point hike was announced. followed on November 2.
In response to a request for comment from Schnabel, an ECB spokesperson said policy decisions are taken at Governing Council meetings after evaluation of all incoming information and a thorough exchange of views.
Knot and Nagel declined to comment.
CONFLICT IN SIGHT?
Even though some economists say that a peak in inflation could now be in sight, central bankers are far from getting inflation under control. In the United States, it is running at more than three times the Fed’s 2% target, according to the central bank’s preferred measure.
Powell said last week that the Fed was “slowing down” the pace of interest rate hikes. Financial markets are now expecting a 0.50% hike at the Fed’s next meeting in mid-December – the same increase the ECB is expected to announce a day later.
Still, Powell and his ECB counterpart, Christine Lagarde, insisted the rate hikes would continue. Some central bankers worry that politicians will respond by increasing government spending and thus worsen the inflationary pressure that their rate hike cure is meant to cure.
Last week, Lagarde warned that such spending could push demand up and further out of phase with supply and so “could force monetary policy to tighten more than is otherwise necessary”, noting signs that this was already happening in the euro area.
Former Bank of England official Charles Goodhart believes record levels of public debt could at some point pose such a risk to financial stability that central banks may have to abandon policy tightening efforts at some point. halfway.
If that were to happen, central bankers “would have to backtrack to prevent the debt market from becoming more disorderly,” Goodhart told Reuters.
BIS’ Carstens said he was confident central banks would remain firm in the fight against inflation. But, he said, the past two years had shown how vital it was that economic policy was coordinated at all levels and that the old idea of central bankers as “first-line policy responders” was exceeded.
“As we move forward, that probably won’t necessarily be the case – at least not to the extent that we’ve seen over the past few decades.”
Reporting by Howard Schneider in Washington, Balazs Koranyi in Frankfurt and Mark John in London; Additional reporting by Lindsay Dunsmuir, Leika Kihara and Francesco Canepa. Editing by Cassell Bryan-Low
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