BETWEEN A ROCK AND A HARDPALCE
W
elcome news last week – interest rates have started to rise on both sides of the Atlantic. The US Federal Reserve and the Bank of England (BoE) finally recognise that the current inflation spike is no transient problem.
Only eccentric autocrats such as Turkey’s President Recep Tayyip Erdoğan think that cutting interest rates can quell inflation. Good luck with that Mr President; Turkey’s annual inflation rose to almost 70% in April, the highest for two decades.
But it’s premature to put out the flags and give three cheers – these rate rises will do nothing to quash inflation. They were too paltry for that. Central banks on both sides of the Atlantic are sitting between a rock – worries that inflation is starting to run out of control – and a hard place – worries that efforts to control inflation by putting up interest rates are going to be too little, too late.
So in the face of news that US consumer prices rose by 8.5% in March on an annualised basis – the highest in 40 years, the Fed last week “delivered the biggest interest-rate increase since 2000” said Bloomberg; the increase was .50%, meaning that the federal funds rate (the interest rate banks use to lend to each other on a short-term basis) will now be 0.75% to 1%. Jay Powell, chairman of the Fed, told Congress in early March that hindsight “says we should have moved earlier”.
The conventional economists’ way of dealing with inflation is that central banks must raise interest rates. That makes credit more expensive; people will spend less and tighten their belts and might even save a bit with higher rates. That conjunction of events will lead to an economy which runs ‘cooler’. At least, that’s the theory.
The UK’s official inflation rate in March was 7%. So the BoE hiked the UK rate from its previous 0.75% to 1%. The gloom deepened as the Bank also said that inflation will reach more
than 10% by the end of this year and a recession will happen – the Bank expects the UK economy to contract by 0.25% in 2023 and remain weak in the next two years. Half a year ago the BoE thought UK inflation would peak at 5%. As for the US, Jay Powell, chairman of the Fed, has long been tarred with his ‘inflation is transitory’ message. The US is now saddled with a negative interest rate of 8% – Dollars held in cash are losing 8% of their purchasing power. As one commentator put it, “while policy is being tightened it could scarcely be called tight”.
Inflating the bubbles Who has confidence in central bankers’ predictions about the future? After getting things wrong, and egregiously wrong for so long, their credibility is at rock-bottom. Yes, there have been some shocking ‘black swan’ (i.e. unpredictable) events (Russia’s invasion of Ukraine being the most extreme example) but prior to that the US, UK and Eurozone economies handled the Covid-19 pandemic extremely poorly. The knee-jerk lockdowns (still being imposed in China) paralyzed the global economy, created all kinds of supply-chain bottlenecks (some remain, reducing exports and pushing up prices), and prevented all kinds of migrant workforces from taking up jobs. Why are vegetable oils in short supply today and much more expensive? Yes, Ukraine is a major global supplier of sunflower oil and its exports have fallen because of the war. But the palm oil plantations of Malaysia, the world’s second biggest producer of palm oil, a vegetable oil used in many different consumer products, depends on migrant labour to pick the palm oil fruits from their trees. Under Covid restrictions tens of thousands of migrant workers could not travel, Malaysia’s palm oil exports dropped, and prices soared. The war in Ukraine has merely worsened a pre-existing situation. Under Covid, interest rates were cut to zero, and ‘quantitative easing’ programmes, large scale asset buying by four leading central banks
28 europeanbusinessmagazine.com
