Few surprises at Sintra
Being a central banker is a lonely job, after all too few people understand or agree with your decisions. So policy makers like to get away over the summer to talk to each other at the Jackson Hole and Sintra conferences. Portugal is very pleasant at this time of year.
A series of speeches at the Sintra event did not add much to the sum of human knowledge. For example, Reuters reported that conversations with seven rate setters at the ECB showed most expected to increase borrowing costs in both July and September. Only one opened the door to a pause in September after recent data showed the economy slowing. As Christine Lagarde said , she is “not seeing enough tangible evidence of underlying inflation — particularly domestic prices — stabilising and moving down”. Martin Kazaks was of the same view as “The softness of the economy is unlikely to deal with inflation, which is still very high with strong risks of persistence”. Several policy makers also indicated that they are concerned at the policy mistakes made in the UK. As one was reported to have said: “We have seen what happened in the UK and we don’t want the same thing to happen to us. It is better to sound a little more hawkish and be prudent about how fast inflation will fall than to be caught out by a negative surprise, which is a problem for a central bank.”
Jerome Powell at the Fed talked in a similar vein: “Although policy is restrictive, it may not be restrictive enough and it has not been restrictive for long enough.” Mary Daly thought two more rate hikes this year a “very reasonable” projection as “it is, in my judgement, prudent policy to slow the pace of policy as you near the destination”. Gabriel Makhlouf was more even handed. “On the evidence that we have at the moment, it does look like, in July, there will be another 0.25% increase. Some colleagues do feel that we’re likely to need further rises in the autumn. I’m just prepared to look at the evidence”.
Andrew Bailey was in understandably defensive mode in his speech. He is correct that any central banker would have struggled to forecast accurately the impact of the series of unexpected shocks that have hit the UK economy. Nevertheless, the second round effects are easier to understand and those have been apparent for the UK for some time, in terms of Brexit, labour markets and a general lack of competitiveness. Turning to actual interest rate decisions, he struck the same tone as his European and American colleagues “I’ve always been interested that markets think that the peak will be short lived in a world where we’re dealing with more persistent inflation,”
Has the economic data in the past week altered the likelihood that central banks will raise interest rates in July, and keep doing so into the autumn? No. A stream of consumer confidence, durable goods orders, and home sales data encouraged economists to revise their estimates for US GDP growth modestly upwards towards 2% for the second quarter. The UK’s CIPS/PMI survey, which tracks manufacturing and services activity, did decline again but at 53 still suggests moderate growth into the summer. Retail sales reports in May showed continued resilience in consumer demand. The Bank will not have been pleased to see other aspects from the CIPS/PMI survey, which highlighted companies are still passing on increased costs to customers, plus the announcement of further public sector strikes. The only good news was evidence that price increases at UK retail stores appear to have peaked. Food price inflation has slowed from 20% towards 15% a year.
Inflation pressures remain in Europe. While French, Italian and Spanish inflation eased, German inflation unexpectedly rose last month. This puts the ECB core inflation rate on course for a moderate increase when reported. This looks to be more important to the ECB than the news of a weakening Eurozone economy. The latest purchasing managers’ index of activity in manufacturing and services declined to a five-month low of 50, whilst the German Ifo survey fell sharply in June as firms tried to get on top of excess inventories. Money supply growth is also slowing. Such weakness in Europe may be related to the continued slowdown seen in China. The Conference Board’s analysis of economic activity has fallen to its lowest level since last December. Not surprisingly there is more speculation of action to ease policy by China’s central bank.
Further ahead, however, we can see tensions about how aggressive central banks should be. Ahead of the 2008 financial crisis, the Bank for International Settlements gave some strong warnings. Recently, the BIS has made its views very clear. “The global economy is at a critical juncture. Stern challenges must be addressed. The time to obsessively pursue short term growth is past. Monetary policy must now restore price stability. Fiscal policy must consolidate”.
Fiscal policy should consolidate, but that is far from the central focus of governments at present. The US Congressional Budget Office released its latest fiscal figures. The government is set to run a deficit of 5.8% of GDP this fiscal year, at a time when the unemployment rate has averaged a mere 3.6%. The fiscal deficit has exceeded that level in only seven years since 1962. Net interest costs have reached 2.5% of GDP. Bond markets put all those issues aside, and moved little in the past week, but after the summer holidays at Sintra and Jackson Hole there may be some autumn storms ahead.
Bond yields at the time of writing
% 2 year 5 year 10 year
USA 4.80 4.14 3.85
UK 5.21 4.61 4.36
Germany 3.274 2.59 2.41
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making