There is a school of thought that says central banks, after a decade of running scared, have found their mojo again.
Their anxiety stemmed from the 2008 crash, when banks panicked in the wake of the US sub-prime property crash and drained the financial system of funds. Only the central banks could make up the difference – with a lending programme known as quantitative easing – and it has been the same story ever since.
Each time central banks attempted to reinvent the old order, hinting that interest rates might inch back towards 2% or even the old normal of 4% to 5%, investors took fright, forcing a U-turn. On several occasions, including at the start of the pandemic, even more publicly insured money was injected into financial markets to preserve the bedrock of the capitalist system.
It became almost a joke in the Square Mile that when financial markets wobbled, Bank of England officials would print more cash, offering it at almost zero interest rates, in the hope it calmed the fevered brows of City traders.
An inflation rate that is heading to 10% or more has left central banks with “no choice”, in the words of former Bank of England official Adam Posen, but to show some guts and push rates higher, even if it means, in the midst of the Ukraine war, triggering a recession.
Once, central banks worried about the collateral damage from higher borrowing costs, and not just the impact on investors forced to acknowledge that the value of their shareholdings depended on central bank support. They worried about small businesses that might be pushed into bankruptcy and mortgage payers forced to hand back the keys to their homes. Not any more, according to those who support central banks taking a harder line.
The first thing to say to those who believe central banks have rediscovered their confidence is that they are diverging widely in their response to the current crisis.
In the US, where the government love-bombed households with cash during the pandemic, most of which has been spent on imports almost as much as domestic goods and services, the central bank has been given licence by financial markets to withdraw some of its cheap money. Now it is on course to push rates much higher. Meanwhile, Japan is in the opposite corner. The Bank of Japan has promised financial markets it will maintain the peace and tranquility enjoyed since the world’s third-largest economy suffered its own property collapse in 1989. To this end, Tokyo will keep borrowing costs below zero for the foreseeable future. In fact, it is almost impossible to envisage an economic trigger that would cause Tokyo to push interest rates upwards.
Over at the European Central Bank, Frankfurt’s finest are coping with a soaring inflation rate, but unlike the US Federal Reserve, almost all the pressure comes from the energy sector and the Ukraine war, not households flush with government cash. ECB officials have made noises about a possible increase in interest rates to calm prices, though inflation is expected to tumble next year without any action, so any rise now would probably need to be reversed in 2023.
The Bank of England occupies a special and confused position, oscillating from one extreme to the other. For the past six months a majority on Threadneedle Street’s monetary policy committee has talked as if the American and British economies were in the same boat. They argued there was too much money chasing too few goods, wages were about to spiral in response to a shortage of workers, and inflation was about to jump, possibly for many years, on the back of this impetus.
Except Britain turned out to be more like the EU. Inflation is going to jump, yes. But there is little pressure from wages because 40 years of draconian employment laws have stripped workers of bargaining power. Much of the increase in earnings reflected in official statistics comes from the stellar wage increases demanded in discrete corners of the labour market – by IT professionals, corporate lawyers, accountants and our old friends, the City traders.
UK inflation is almost exclusively the result of higher fuel and energy bills, coupled with an increase in food costs due to supermarkets jacking up prices to recover margins squeezed by competition over the last decade.
Bank governor Andrew Bailey, for so long the harbinger of higher interest rates, now sings a different song, even after his rate-setters last week increased the base interest rate for a fourth time to 1% and signalled a few more rises to come. Britain was about to enter a “very difficult period” of low growth and high inflation that could bring with it higher unemployment, he said.
Fear stalks the central bank again. It means interest rates are likely to be capped at 1.5% and might not increase beyond 1%. Cuts next year are possible.
