This week’s global flurry of central bank announcements gave nervous voters and edgy investors what they wanted: A lot of stern talk about inflation, but little in the way of drastic action.
From Ottawa and Washington to London and Frankfurt, central bankers found ways to signal they are taking inflation seriously, while avoiding what financial markets and homebuyers fear most – a dramatic swing to significantly higher interest rates.
Does the new willingness to acknowledge inflation constitute a pivot toward a new, harder line? Many headlines insist it does. More accurately, though, it is reassurance that central banks haven’t gone soft. For now, policy makers are leaving “the door open to literally everything,” as Roberto Perli of research firm Cornerstone Macro puts it. Given the fog of uncertainty around Omicron’s impact on the economy, this seems wise.
So call this week’s action a rhetorical tightening. Central bankers in Canada, Britain and the United States are competing to sound tough on inflation. They are reiterating their commitment to stable prices and purging the much-derided “transitory” terminology from their vocabularies, but they aren’t actually committing themselves to a rapid rise in interest rates, especially at a time when a new wave of COVID-19 infections is spreading around the world.
Market reaction suggests most investors are fine with this cautious strategy. Instead of spiking in anticipation of higher rates ahead, benchmark 10-year bond yields in Canada and the United States are edging down from already modest levels. Share prices, meanwhile, have diverged, with the tech-heavy Nasdaq index falling on Thursday, but European and Asian stocks rising and Canadian stocks barely changing.
The lack of any universal market reaction may simply reflect relief at the lack of any hard-line surprises from policy makers. But it also suggests that many investors continue to believe that today’s red-hot inflation will peak in the first half of next year, then cool, without the need for a violent series of rate hikes. For all the recent fuss over what transitory means, the word still seems to sum up what many policy makers think about current price pressures.
Central bankers are doing their best to keep their options open. Their language has toughened in many cases, but anyone looking for a full-out assault on inflation, in the style of former Fed chair Paul Volcker a generation ago, has gone away disappointed.
The most aggressive action among major central banks came from the Bank of England, which nudged its key interest on Thursday from 0.1 per cent to 0.25 per cent, still in rock-bottom territory. It warned further “modest” increases in rates might be needed in the months ahead to control surging inflation, but it also cautioned that the risks around the medium-term inflation outlook are “two-sided” – in other words, inflation may run hotter or cooler than expected. It still expects inflation to fall in the second half of 2022.
For his part, Bank of Canada Governor Tiff Macklem said in a speech on Wednesday that “we are not comfortable with where we are on inflation” but added he expects price pressures to ease after next summer.
In Washington, Federal Reserve chair Jerome Powell unveiled plans to step up the pace of the Fed’s withdrawal from its pandemic-era bond buying program, which is likely to set the stage for three interest rate hikes next year. But there was little shift in how high policy makers see rates rising in the medium term. The median forecast from Fed officials now sees the key Fed funds rate peaking at 2.1 per cent in 2024, up only slightly from 1.8 per cent previously.
In contrast to the Fed, the European Central Bank took a far less aggressive tone on Thursday. It said it would scale back some of its bond-buying programs in response to rising inflation, but ruled out raising interest rates in 2022. The ECB predicted inflation would edge up to 3.2 per cent next year, but then fall back to 1.8 per cent in 2023 and 2024.
The varying reactions underline the very different stages of economic recovery in various countries. It also demonstrates how Omicron is clouding the economic outlook. Most of all, though, it shows that more than a year and a half after the pandemic struck, the world is still trying to figure out what normal looks like.
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