Central bankers take sharply different readings of inflation threat

Central bankers have outlined starkly different responses to the global surge in inflation, with senior US and UK officials signalling that interest rates are likely to rise soon in their countries despite such a policy shift remaining a distant prospect in the eurozone.

Philip Lane, the European Central Bank’s chief economist, said on Monday that the eurozone was in a “completely different” situation to other countries, adding there were “powerful reasons” for inflation to fall in the region next year. It would be “counter-productive to tighten monetary policy at the current juncture,” he added.

In contrast, US Federal Reserve vice-chair Richard Clarida said the “necessary conditions” for US interest rates to rise from their current near-zero level will be met by the end of next year should the economy progress as expected.

The Bank of England has been criticised for leading markets to believe there would be a rate rise at its meeting last week, when it left rates unchanged. Even so, governor Andrew Bailey has insisted that the vote was a “close call” and the BoE “won’t bottle it” if the economy develops in line with its forecast.

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Their comments highlight the diverging views among central banks over how quickly they should tighten monetary policy in response to rising global inflation. Resurgent consumer demand, supply chain bottlenecks and rising energy costs are pushing prices higher around the world.

Analysts said the ECB was bound to be the slowest to raise rates after it spent much of the past decade struggling to avoid Japan-style deflation. Eurozone economic activity and employment levels also remain weaker than in the US and UK.

“On all fronts, the risk of a self-sustained wage-price spiral looks much lower in the euro area than in the US or in the UK,” said Frederik Ducrozet, strategist at Pictet Wealth Management.

The US economy has already rebounded above pre-pandemic levels, boosted by its stronger fiscal policy response. In contrast, the eurozone is only expected to achieve pre-pandemic levels of output later this year. Although the bloc’s unemployment levels have returned to pre-crisis levels, millions of people remain on furlough schemes and have left the workforce.

Erik Nielsen, chief economist at UniCredit, said: “The key differences with the eurozone inflation outlook compared to the US are the difference in fiscal stimulus and the much more flexible US labour and housing markets, while UK inflation outlook is being affected by the long-term hit to supply stemming from Brexit and the likely effects of sterling depreciation.”

Clarida said on Monday that if the US unemployment rate drops to 3.8 per cent from its current 4.6 per cent, as projections suggest, that would be consistent with his assessment of maximum employment — and warrant tighter monetary policy.

The Fed’s preferred inflation gauge, the core personal consumption expenditure index, surged to 3.6 per cent in September from a year earlier and is on track to end the year at 3.7 per cent, according to its latest forecasts.

In the UK, consumer inflation has averaged the BoE’s 2 per cent target over the past decade. It also has tighter labour markets than the eurozone, and the BoE will pay particular attention to the labour market effects of the end of the UK’s furlough scheme in October.

“There will actually, as a matter of fact, be two official labour market data releases between now and our next meeting” in December, Bailey said last week.

By contrast, Lane said eurozone inflation had averaged 0.9 per cent from 2014 to 2019, adding: “Despite the high current inflation rate, the analysis indicating that the euro area is still confronted with weak medium-term inflation dynamics remains compelling.”

Eurozone inflation reached a new 13-year high of 4.1 per cent in October — well above the ECB’s 2 per cent target. But Lane said several factors pushing up prices today were expected to fade next year, including supply chain bottlenecks and the impact of a temporary German tax increase.

He added that the eurozone’s large current account surplus, generated by more exports than imports, highlighted the bloc’s “weak medium-term aggregate demand conditions”.

Furthermore, despite vast government aid packages in response to the pandemic, Lane said fiscal policy in Europe was “constrained by high aggregate national debt levels and the lack of a permanent central fiscal capacity”. 

“These factors reinforce our strategic assessment that extensive monetary accommodation is required to ensure that inflation pressure builds up on a permanent basis in order to stabilise inflation at 2 per cent over the medium term,” he said.

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