On Wednesday (June 29) local time, the annual meeting of the European Central Bank was opened in Sintra, Portugal. Federal Reserve Chairman Powell, ECB president Lagarde, and Bank of England president Bailey were invited to attend the annual monetary policy forum of the European Central Bank and deliver a speech. Powell believed that sustained inflation was a great threat to the economy, while Lagarde said that the period of low inflation was difficult to reproduce. Bailey admitted that the British economy was at an inflection point and people's income was impacted.
Powell: unable to promise soft landing
Fed chairman Powell said in his speech that raising interest rates may excessively slow the economy, but the greater risk is sustained inflation.
When talking about the soft landing of the economy, Powell said, "we believe that while maintaining a strong labor market, there is a way to achieve a 2% inflation rate.". Then he quickly added, "we can't guarantee that we can do this. Obviously, this will be a very challenging thing, but the longer the inflation lasts, the more unstable the public's expectations of inflation, and the road to the so-called 'soft landing' becomes more challenging."
This statement is similar to Powell's speech at the hearing of the US Congress last week. When facing Senator Warren's doubt that the continued interest rate hike may push the economy "off the cliff", he said that (recession) is certainly a possibility. Considering the geographical conflicts, commodity prices and supply chain issues, whether the economy can achieve a soft landing depends to some extent on factors beyond the control of the Federal Reserve.
The data released by the US Department of Commerce on Wednesday (June 29) showed that the final value of GDP in the first quarter fell by 1.6%, 0.1 percentage points lower than the second reading data. With the Federal Reserve actively tightening monetary policy to curb inflation, concerns about economic recession have increased. At present, Wall Street institutions have reduced the economic growth rate in the second quarter to less than 1%. Combined with the decline in retail sales in May, the decline in housing construction and building permits, consumer confidence hit a 16 month low in June, and the risk of technological recession is increasing. Bank of America predicts that due to the tightening of the financial environment, the U.S. GDP growth will slow to a level close to zero by the second half of 2023. Overall, the probability of a recession next year is 40%.
However, Powell is still optimistic about the current economic health. The situation of households and enterprises is very good, and the labor market is "very strong". "Is it possible for us (interest rates) to go too far? Of course, it is possible. But I don't agree that this is the biggest risk facing the economy."
He then revealed that the Federal Reserve needed to raise its benchmark policy interest rate range to the limit level (neutral interest rate) "soon". "The biggest policy mistake will be the failure to restore price stability, and the Federal Reserve will not allow the transition from a low inflation environment to a high inflation environment. If you start to see the serious decoupling of long-term inflation expectations, you will have fallen behind by then. We haven't yet. The Federal Reserve is doing what needs to be done to ensure that it won't fall behind."
Lagarde: the era of low inflation is gone forever
Lagarde said that the era of ultra-low inflation before the epidemic is unlikely to recur, and she is ready to "gradually" raise interest rates in the next six months to deal with "stubborn high inflation".
Lagarde said that the economic recovery is ongoing, especially driven by the service industry. The European Central Bank is expected to raise interest rates twice in the third quarter from July. If necessary, more actions must be prepared, and interest rates should be raised gradually to cope with high uncertainty. She then denied that the possibility of raising interest rates by 50 basis points had been completely cancelled, saying that "as the uncertainty subsides, the European Central Bank may act more decisively".
The energy crisis caused by the situation in Ukraine makes the European region face huge price pressure. In April, the consumer price index (CPI) of the euro zone has reached a record 8.1%. Food and energy prices continue to constitute the main part of consumer spending pressure. As the producer price index (PPI) of many euro zone countries is much higher than 30%, the overall CPI risk is still significantly higher, especially in the case of the continued weakness of the euro. On Wednesday, the euro / dollar fell 0.7%, falling below the 1.05 level.
Data released by the Spanish Bureau of statistics on June 29 showed that the country's CPI increased by 10.2% year-on-year in June, hitting a 37 year high. At present, the market expects that the eurozone CPI in May announced on Friday will continue to set a record high of 8.3%, which may lead to more calls for bolder action on interest rates. However, radical interest rate hikes and the cessation of asset purchases mean that the bond market faces huge risks, especially in highly indebted economies such as Italy.
Lagarde mentioned that the European Central Bank meeting in July will consider new tools to prevent the fragmentation of borrowing costs in the eurozone countries. As one of the barometers of financial pressure in the euro zone, with the expected intensification of interest rate hikes, the spreads of euro zone government bonds widened rapidly in mid June. The European Central Bank held an emergency meeting two weeks ago, saying that it would "flexibly use" to reinvest the redemption in its epidemic emergency purchase plan (PEPP) portfolio to maintain the function of the monetary policy transmission mechanism.
The latest interest rate futures show that investors expect to raise interest rates by 25 basis points next month and 50 basis points in September, and the interest rate may rise to 1% at the end of the year. For the European Central Bank, inflation is impacting the economy. The latest data shows that high price pressure is making consumers cut spending. The latest purchasing managers' index (PMI) in June shows that business confidence is declining sharply, and the growth of new orders is stagnant. Economic pressure may become an important obstacle to further actions by the European Central Bank.
Britain faces a dilemma in raising interest rates
Bailey, the governor of the Bank of England, said that the Bank of England could choose to take "stronger action" against inflation, and did not rule out raising interest rates by 50 basis points at the policy meeting one month later, on the premise that "if there are continuous signs that price inflation is a problem".
Data released by the British Bureau of statistics last week showed that the UK CPI hit a 40 year high in May, reaching 9.1%. Affected by this, GfK, the main indicator of consumer confidence in the UK, fell to its lowest level since records began in 1974. "There are signs that the composition of inflation is changing from commodity supply shocks to energy and food shocks, which I describe as supply chain shocks in the post epidemic era. We will observe this very, very, very carefully." He said.
Since last year, the Bank of England has announced interest rate hikes at five consecutive interest rate meetings. At present, the British economy is facing serious challenges. In addition to inflation, brexit has exacerbated supply and labor shortages. The tension between London and Brussels has continued to heat up on the issue of Northern Ireland recently.
These factors also make the path of interest rate hike variable. Bailey admitted that Britain is at the inflection point of economic growth, and the people have been hit by huge real income. "In addition to preparing to take strong action against inflation when necessary, the central bank has other options." He said in the panel discussion: "in some cases, we have to do more work. As for the next meeting, we still have a month to raise interest rates. But you should not think that this is the only option on the table."
In the latest interest rate meeting, the internal differentiation of the Bank of England further intensified, and some members were worried that the radical monetary policy would affect the economic recovery. Swati dhingra, who will become the new member of the policy committee of the Bank of England, said on Wednesday that the Bank of England should gradually take action to tighten monetary policy, because the economic slowdown now seems to be faster than previously thought.
Sterling / dollar fell below 1.21, a two-week low. Since this year, the pound has depreciated by more than 10% against the US dollar. The governor of the Bank of England regards exchange rate fluctuations as a neutral factor, but it is indeed one of many factors to be taken into account in analyzing how inflation evolves in the future.