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As children are on their way back to school again, laden down with their new equipment, central bankers have a busy schedule ahead as they return to the hush of their offices.
USA: Stony Road to Monetary Policy Normalization
In the US, the Jackson Hole seminar at the end of August sketched out the roadmap towards the gradual elimination of asset repurchases, otherwise known as tapering. But the specific timetable regarding timing, speed and extent of this process are still far from clear. Whilst there is generally a consensus on implementing emergency accommodative measures, there is less agreement on the withdrawal of monetary infusions, which may therefore be a cause of disruption on markets. In addition, the Chair of the US Federal Reserve (Fed) Jerome Powell, is campaigning for reappointment, which may incite him to act in the interests of the government, rather than those of his own institution. The road back to monetary normalisation, implying a withdrawal of liquidity injections followed by rate hikes, thus looks a narrow and perilous one. Whilst injecting liquidity is easy enough, stopping it is another matter. The year-end is scheduled for a first test.
Inflationary pressure rising in Europe - Parallels to U.S. Development?
In Europe, where the upturn lags that of the US by a couple of months, inflationary pressure is gradually appearing. This was evident in the inflation numbers published on 31 August, which showed a clear rise, ahead of expectations: 3% for overall inflation and 1.6% core inflation excluding the most volatile elements energy and food. The eurozone has been relatively immune to inflationary pressure so far, but this is starting to build. Although August numbers are partly distorted by timing issues, the mechanism at work looks remarkably similar to that affecting the US over the last few months: global supply chain tensions, a rise in commodity prices, a stampede for services linked to the reopening, etc.
There is currently a mass of supply and demand imbalances. Should they prove permanent, these are all factors likely to create a wage-price spiral, and a push to initially less accommodative and then tighter monetary policy. This may seem a long way off in Europe, but if a clear parallel to the US can be drawn for the emerging trajectory of inflation, investor expectations for Europe will be influenced by the US scenario.
Furthermore, whispers are gradually being heard in the corridors of the ECB located in Frankfurt of intentions of removing the Pandemic Emergency Purchase Programme (PEPP), a tool introduced in response to the pandemic and due to expire next March in any case. This will coincide with the eurozone reaching its pre-pandemic GDP level. Christine Lagarde could start to prepare for this test as early as 9 September, at the first post-vacation meeting of eurozone central bankers.
So, as ever fewer upside surprises of economic strength emerge with every passing week, greater caution looks advisable in this environment of growing uncertainty on monetary direction. Unless of course central bankers pass this test with bravery?
By Olivier de Berranger, CIO, LFDE
Written on 03/09/2021