Last week the three major central banks staged a confrontation between monetary authorities and financial markets, with the latter not seeming to believe in the permanence of a restrictive policy for much longer.
Scene 1
Jerome Powell, governor of the Federal Reserve, comments on the seventh rate hike by the central bank in the last year. Mr. Powell admits that yes, inflation is starting to come down but adds that interest rates need to stay at sustained levels to force prices down. Market niche and both stocks and bonds continue to rise.
Scene 2
Christine Lagarde, president of the European Central Bank, goes down hard. Not only did the ECB decide in its February meeting to raise rates by 50 basis points, but it puts pen to paper that an action of the same magnitude will also be repeated in March. And if that were not enough, the governor of the ECB gravely affirms that core inflation continues to cause concern and that for this reason, monetary policy will still have to work hard to bring the cost of living back close to the medium-term target. Market niche and both stocks and bonds continue to rise.
Briefly, what has been described is what happened between Wednesday, February 1, and Thursday, February 2, when the main central banks – including the unmentioned Bank of England – tried to carry out a very dangerous and twisted exercise of keeping one foot in both camps. A punch in a velvet glove that does not seem to have hit the financial markets. Because the intention of the central institutes is to dampen every slightest enthusiasm, to make it clear on the one hand that the drop in prices has begun and on the other to unleash enthusiasm on the financial markets – poured into the game of supply and demand for goods and services – can be terribly counterproductive and force the monetary authority to go beyond what was planned with a phase of tightening on rates. The trouble, if we want to define it that way, is that investors think that the work still to be done underlined by Powell and Lagarde is just a bluff to achieve the second objective: to calm a wave of enthusiasm on the markets.
When monetary authorities and financial markets play poker, the situation becomes extremely dangerous. But this is nothing more than one of the side effects of the high inflation period we are experiencing: a real erosion of central bank credibility. A recent study by three Dutch economists – anticipated on the CEPR website – takes a snapshot of the degree of trust Dutch citizens have in the European Central Bank. The survey shows that among those most exposed to inflation (and therefore have higher perceived inflation levels) confidence in the “calming” capacity of the ECB is decidedly low. Among those with a perceived inflation level above 30%, for example, they have the propensity to trust the monetary authority 24 points lower than the average. Not to mention that for 70% of those interviewed in the report, it is the government’s job to manage inflation; while 50% cite the central bank among the powers able to control the cost of living.
The next few months will be very delicate for the central institutions. After having exaggerated with the term temporariness, the markets – and investors – would not be tender in the face of a new misjudgment.
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