Left to right: Jay Powell, Christine Lagarde, Andrew Bailey
It was enough to lift an eyebrow. According to Threadneedle Street lore, the Governor of the Bank of England is so powerful that it didn't take a word to get the message across.
Sir John Cunliffe, who sets the rate of interest today, but also served as the Treasury's representative in meetings on monetary policy from 2002 to 2007, noting in a speech that the Bank actually «choosed to rely on the governor's eyebrows for both oversight and insolvency issues.» banks".
Not only the Bank of England prefers to be brief. Just over a decade ago, three words from former European Central Bank President Mario Draghi marked a turning point in the eurozone crisis.
His promise to do «whatever it takes» calmed the financial markets instantly, while the level of «vigilance» of his predecessor Jean-Claude Trichet would also have signaled if another rate hike was coming.
How times have changed. Russia's lockdowns and invasion of Ukraine have pushed central banks into a world where one of the sharpest recessions in economic history has been followed by a spike in inflation as the economy rebounds and the war sends gas prices skyrocketing.From massive stimulus and bond buying, 11 consecutive interest rate hikes in the UK and nine in the US followed in response.
But there is growing concern about how central banks around the world are handling the latest crisis, making it feel like what was once «the only game in town» is losing credibility.
Mohamed El-Erian, chief economic adviser to Allianz, says the problem stems from «a degree of arrogance never seen before.»
He adds that US Federal Reserve Jerome Powell made «a lot of mistakes» that, in his opinion, “they will have a significant impact not only on the US economy, but also on the global economy.”
“What I saw in the Federal Reserve is of great importance. concern for the welfare of central banks,” he warns.
El-Erian says it all started with the Fed denying there was an inflation problem. “Throughout 2021, the Fed has absolutely insisted that inflation is transient,” he notes. «And that ruled out any other interpretation.»
It was the same story on this side of the Atlantic. In the BoE's August 2021 economic audit, the word «temporary» was mentioned 13 times. Even as it became increasingly clear that price pressure was brewing, the Bank continued to assume that inflation was temporary in November, raising interest rates only after it felt that the end of the holiday program would not lead to a spike in unemployment. /p>
Michael Weber, associate professor of finance at Booth University of Chicago, believes central banks are experiencing a «potential crisis of confidence» because of disunity that began with a failure to acknowledge the pressure families face.
“If the head of the central bank comes out and tells people that inflation is temporary, you have nothing to worry about, it will automatically fall, and this does not reflect the feelings of the people,” he says.
Mr. Weber adds that central banks also made a «fundamental mistake» by focusing on what economists call «core inflation», which rules out erratic fluctuations in energy and food prices just as food prices rose by a fifth.
“So there was already a discrepancy between what politicians were saying and what people were perceiving, which created the beginning of a potential crisis of confidence in central banks,” he says.
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Another former Bank of England politician I agree that honesty is not the best policy. “There was a certain degree of covering up the backside where they had to just admit that they made a little mistake,” he says.
El-Erian is also annoyed at the way the Fed has reacted to its message. as soon as he realized that inflation was not going anywhere.
«In late November, Powell said the Fed would 'remove' the word [transitional] from its lexicon,» he says. “However, it did not take political action. So you have this ridiculous situation where in mid-March, when inflation was at 7.5%, the Fed was still pumping liquidity into the economy.” Erian believes the damage has already been done.
Now investors are increasingly starting to bet against the Fed. For example, the latest central bank guidance on interest rates shows that policy makers expect the federal funds rate to remain at 5.1% this year, then fall to 4.3% next year, and approach 3% in 2025.
But traders have doubts about the resolve of the central bank, especially after the collapse of Silicon Valley Bank exposed some vulnerabilities in the banking system.
Investors are also testing the strength of the current ECB President Christine Lagarde&# 39; s argue that there is no compromise between price stability and financial stability after Credit Suisse almost collapsed.
At one point this month, investors bet that by the end of this year, interest rates would be a full percentage point below the Fed's forecast. “I've never seen such a big gap,” says El-Erian.
Commodity traders say the recent rise in gold is another sign that faith in the Fed's ability to control inflation is waning.
Anxiety is also growing on this side of the Atlantic. A survey released by the Bank of England shows that confidence in its ability to control inflation hit an all-time low at the end of last year. Analysts at Bank of America recently highlighted that UK mortgage rates are likely to rise in the coming weeks due to a misunderstanding of Threadneedle Street inflation.
Nervousness about the credibility of the Fed has been reflected. in recent market fluctuations. A recent study from Harvard University shows that Powell's last six press conferences have caused the S&P 500 stock index to fluctuate more than $300 billion (£242 billion) in value or gain in value.
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The researchers also found that volatility was «three times higher during press conferences held by current chairman Jerome Powell than at press conferences by his predecessors, and they tend to change the initial market reaction to committee statements» .
El-Erian says that failure to acknowledge these mistakes could raise questions about the effectiveness of an independent central bank, which he says is the cornerstone of good policy.
“These are multiple mistakes without a learning process,” he adds. «And the reason I'm so worried is that when you don't admit your mistakes and learn from them, you keep losing confidence.»
The countdown has already begun. The Australian Treasury began reviewing its central bank last July after Gov. Philip Low spoiled a forecast that interest rates would remain at record lows through 2024. The resulting reforms will make the bank more accountable and transparent, but analysts predict it will also result in the current governor's term not being renewed.
Martin Weale, professor of economics at King's Business School, knows a thing or two about curbing inflation. Early in his tenure, when he set interest rates at the Bank of England in 2010, inflation was rising, peaking at 5.2% in September 2011.
After all, this particular period of high inflation was transitory. In his 2016 farewell speech, Wil noted that inflation had averaged exactly 2.05% during his time at the Bank.
While he believes the past 18 months have likely resulted in «some loss of confidence» in the Bank, Weale says it didn't «fly out the window.» He adds that some modest pie may be in order after recent events suggest that the period after the so-called «good» decade of «non-inflationary, consistently expansionist» production in the late 1990s after the Bank gained independence is unlikely whether it will happen again. .
“Perhaps central banks were borrowing too much during a period of unusually stable inflation,” Weale says. “There were disputes, is it because of politics or just luck? And perhaps the architects of politics were inclined to think that it was all their doing"
El-Erian is more lenient on the Bank, noting that it was the first major central bank to raise interest rates. He says Gov. Andrew Bailey's controversial statement that workers shouldn't demand massive wage increases to avoid fueling inflation was also an acknowledgment of the difficult dilemma facing policymakers. This is a position that presents central banks with what El-Erian calls a “trilemma.”
“I think the Fed, in particular, will be faced with three choices at the end of the summer" he adds. “I think inflation will remain tight at 4 to 5 percent. So the number one choice would be to keep inflation at 2% and crush the economy. But it supports the credibility of the central bank.
“Option number two is to change the inflation target. But you can't change that when you've been bored for so long. Option number three is «fake in the head»: keep promising people 2 percent, but you run your policy at 3 to 4 percent and hope that it will correct.
«The sad thing is, there's no reason to be here. If politicians had started raising interest rates sooner, we would not be in second place in a world where there is no good policy action.
“Economists tell you when you are no longer in the world of first best policy, then every action you take will have consequences.”
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