Macro Moments Weekly: Three Banks, One Global Headache

Key Takeaways:

• Inflation Risks Look Similar Everywhere, but Policy Responses Don’t: The ECB and the Fed responded to persistent energy-driven inflation and the risk of higher inflation expectations becoming entrenched. The Bank of England shares many of the same concerns yet chose to leave rates unchanged.
• The BoE May Be Waiting on Fiscal Policy, Not Economic Data: With the UK Budget scheduled just before the next MPC meeting, policymakers may be holding fire until they can assess whether government spending plans will support or undermine the fight against inflation.
• The Real Battle Is Between Monetary and Fiscal Policy: Central banks can tighten policy to curb inflation, but their task becomes much harder when governments are simultaneously stimulating demand. Until that tension is resolved, inflation control will remain a slow and uncertain process.

So there we have it. Three central bank meetings in a week—two have raised rates, one didn’t. To understand why the UK’s Monetary Policy Committee (MPC) did not follow the US Federal Reserve (Fed) from a day earlier or the European Central Bank (ECB) a week earlier, let’s look at their comments. ECB President Christine Lagarde was pretty blunt: ‘Energy shock first, growth second.’ She sees energy inflation in double digits in the next few months and further risks from geopolitics and is moving to stop that price rise feeding into core inflation and wages. This, with the double whammy of rising food prices, meant the ECB had to act, and would likely continue to do so.

Fed Governor Kevin Warsh sounded a similar tone. To summarise: Growth is decent and resilient, demand doesn’t justify an easier policy stance, oil prices are rising and inflation expectations are becoming entrenched. The economy is simply too strong to expect inflation to fall—in particular in services.

The Bank of England echoed all of these comments, noting the higher-for-longer energy prices, the greater the risk of material second round effects. While inflation is at 3.1%, not dissimilar to that in the United States and Europe, it noted “the risks to the inflation outlook are tilted to the upside.” This has forced the Governor to write to the Chancellor, his boss, to explain why. But in that letter, he admits inflation will likely rise to above 4% in 2027. In other comments the MPC warned that domestic energy prices could rise 24% in January.

So if anything, the inflation outlook in the United Kingdom looks more uncertain than elsewhere, and yet there is still no movement on rates. The key reason may lie in the calendar: The next meeting of the MPC, rather ominously, is on Guy Fawkes Day, 5th November. That’s a week after the first budget from the new government, on 28th October. Could it be that although the inflationary signals in the United Kingdom are exactly the same as around the world, the MPC is waiting to see if the government can find a compromise between the spending desires of its backbenchers and the fiscal restraint demanded by the markets.

In that respect, the Bank of England is in the same bind that all the other central bankers find themselves in, namely, how do you restrain inflation after a supply shock when the government is trying to pump money into the economy? Some have more scope, whilst some have less. The big spenders are China, the United States, France and India. Oddly, Germany and the United Kingdom are somewhat more restrained than most. Until this tension is resolved, it seems like only monetary policy can restrain inflation, whether it is imposed by the central banks or by the market. Famously, monetary policy works slowly, even more slowly now that most of us have fixed rate mortgages.

Parting Shot

Yet another European incumbent has lost power: This time in Sweden, but it was very close. The left-of-centre bloc won 176 seats, the right 173. Just 50,000 votes separated the two parties from eight million voters. The resignation by the defeated Prime Minister was done, of course, on X. The acceptance by the new on Instagram. The tricky bit is getting a diverse left-wing coalition to agree on taxes and spending. Just like the UK.