As they warned that tight labour markets continue to push up wages and costs, the world’s central bankers signalled their willingness to raise interest rates and keep them at high levels.
At a conference held in Sintra, Portugal the heads of the US Federal Reserve and the European Central Bank warned that additional action could be required to bring the inflation towards the target of around 2 percent. This is despite predictions by some economists that rate increases would trigger a financial crisis or recession.
The Fed Chair Jay Powell said that although the policy was restrictive, it might not have been restrictive enough. It has also not been restrictive long enough.
He added that “the labour market really pulls the economy”, signaling the Fed may increase interest rates during its next two meetings, after a pause this month.
Before Powell’s speech, the futures market had a 79 percent probability that the US central banks would raise rates in July. This was up from 74 percent before Powell’s remarks.
Frederik ducrozet is an economist with Pictet Wealth Management. He said that bankers are “willing to tolerate mild recessions if it’s necessary” in order to reach their goals.
Gita Gopinath, IMF’s deputy director, warned that higher rates could trigger a financial systemic crisis.
Investors expect that the Fed, ECB, and Bank of England will increase their policy rate a few more times over the next couple of months. This is because the economic growth has remained resilient, the labour market remains tight, and wages continue to rise rapidly.
The rate of inflation is falling in both the US and the Eurozone. However, it is declining more slowly if you exclude energy and food costs. Powell stated that although housing and goods prices have fallen, the Fed has not yet seen any “real improvement” in the labor-intensive service sector.
The Fed chairman added that he did not believe a recession was necessary to bring the labour demand and supply into balance.
He said that although wage pressures were high, they are on the decline. There are still 1.7 jobs for every unemployed American.
BoE Governor Andrew Bailey stated that headline inflation could drop “very dramatically” in the next few months. He said the core inflation rate – excluding food and energy – was “much more sticky” and that the UK’s shrinking labour force, due to the coronavirus outbreak and people quitting work, could lead to high price pressures.
After decades of near-stagnation, even Bank of Japan Governor Kazuo Ueda stated that wages and prices are increasing in Japan. This has allowed officials to begin considering abandoning their ultra-loose money policy.
“We are beginning to see changes in expectations of inflation and wage setting behaviour,” said Ueda who was appointed BoJ chief earlier this year. This is a positive sign.
Christine Lagarde said that the ECB hosted the conference and her institution “did not see enough tangible evidence” of underlying inflation, particularly in the domestic price, stabilizing or moving down.
Eurozone Inflation is 6.1%, compared to 4.1% in the US and 8.7% in the UK.