The Problem with the Fed's Bet on a Slowdown
Ben Bernanke has laid his cards on the table; by pausing in the rate hike cycle (though explicitly not necessarily halted) he is gambling that slower growth will pull inflation back to acceptable levels, without the need for further - potentially crushing - rate hikes.
In doing so, he is gambling his future on a number of uncertainties, the biggest of which is probably whether slowing growth will bring down inflation. Indeed, he has openly acknowledged he is uncomfortable with inflation as it is, and that it may creep higher, albeit at a slower rate. However, although the economic cycle and the inflation cycle are connected, the relationship is beset with a substantial (and incalculable) time lag.
At present a lot of pundits in the US (as they are in the UK) are focused on the declining spending power of the consumer - we read daily that if all you consume is flat screen TVs, you are laughing, but if you have school fees/a car/central heating - and also eat food now - personal inflation is way way above the officially given figures. Unfortunately for the consumer, wage increases have been held back, ostensibly by advances in globalisation - the ability to shift production to lower wage areas keeps wages elsewhere restrained. However, that may be a fallacy applied to help make a story understandable, and we may be about to see the rise of wage inflation. The reason this may happen is that individual workers can see corporate earnings rising strongly, and although these are historical figures relating to the last quarter, the reaction from workforces will be forward looking - hence the timelag between inflation and the economic cycle. Even if a turndown is in prospect for many firms, unions will carry previous earnings data into the negotiations on wages, and with the pressure on wallets being felt by most of us, I doubt retraint is a word they are going to be comfortable with.
In the US, there are a number of other factors which undermine the lower-growth/lower-inflation gamble, including 3rd quarter spending on defence, potential for a capex rebound, and continuing rises in energy prices. Some do not apply to the UK, but the main point about prospects for wage inflation do. In view of this, I believe the BoE will find it very difficult to resist the pressure for one more hike this year.
In doing so, he is gambling his future on a number of uncertainties, the biggest of which is probably whether slowing growth will bring down inflation. Indeed, he has openly acknowledged he is uncomfortable with inflation as it is, and that it may creep higher, albeit at a slower rate. However, although the economic cycle and the inflation cycle are connected, the relationship is beset with a substantial (and incalculable) time lag.
At present a lot of pundits in the US (as they are in the UK) are focused on the declining spending power of the consumer - we read daily that if all you consume is flat screen TVs, you are laughing, but if you have school fees/a car/central heating - and also eat food now - personal inflation is way way above the officially given figures. Unfortunately for the consumer, wage increases have been held back, ostensibly by advances in globalisation - the ability to shift production to lower wage areas keeps wages elsewhere restrained. However, that may be a fallacy applied to help make a story understandable, and we may be about to see the rise of wage inflation. The reason this may happen is that individual workers can see corporate earnings rising strongly, and although these are historical figures relating to the last quarter, the reaction from workforces will be forward looking - hence the timelag between inflation and the economic cycle. Even if a turndown is in prospect for many firms, unions will carry previous earnings data into the negotiations on wages, and with the pressure on wallets being felt by most of us, I doubt retraint is a word they are going to be comfortable with.
In the US, there are a number of other factors which undermine the lower-growth/lower-inflation gamble, including 3rd quarter spending on defence, potential for a capex rebound, and continuing rises in energy prices. Some do not apply to the UK, but the main point about prospects for wage inflation do. In view of this, I believe the BoE will find it very difficult to resist the pressure for one more hike this year.
posted by Jambutty at 10:53 am
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