Once feted for pandemic heroics, world’s central banks now face an uneasy crowd

By Howard Schneider, Julie Gordon and Leika Kihara

WASHINGTON, June 17 (Reuters)World central bankers, who shared the limelight for sidestepping a pandemic-induced depression with swift action two years ago, are now stumbling the following as they attempt to quell a surge in inflation that no one predicted or have could warn.

If their answer to the economic crisis unleashed by the pandemic seemed bold and forward-looking, with its endless list of new programs and massive monetary stimulus, the last few months have been an erratic, even awkward phase of failed forecasts, embarrassing my culpaincreased political control and signs of loss of confidence.

Managing inflation is central to a central bank’s mission, and from major players like the US Federal Reserve and the Bank of Japan to regional institutions like the Bank of Canada and the Reserve Bank of Australia, recent events have dealt a blow to their credibility as they catch up with politics and, in doing so, increase the likelihood of a recession.

“They had blinkers on. They didn’t want to hear about stable or upside risk to inflation in response to massive stimulus around the world, government and monetary,” said Derek Holt, chief economics officer. financial markets at Scotiabank in Toronto. . “I think they had that evidence even as 2020 unfolded,” but kept emergency programs for another year and viewed an initial rise in inflation as transitory.

The result: In just over a week, the Fed snuck in financial markets with a Increase of 75 basis points in interest rates, its first increase of this magnitude since 1994; the European Central Bank rushed to new contingency plans to control government bond spreads; the Swiss National Bank approved an unexpected rate hike; Bank of England forecasts suggested stagflation was developing; and Bank of Japan Governor Haruhiko Kuroda was forced to apologize after scathing criticism over remarks that households had become “acceptable” of higher prices.

Kuroda’s predicament was emblematic.

Inflation in Japan edged above 2% on an annual basis in April, low from above 8% recent consumer price increases in the United Statesfor example, and effectively met the BOJ’s 2% target after decades of concern over the opposite problem of deflation.

Yet the idea of ​​households accepting higher prices has proven taboo, something central bankers and elected officials around the world are quickly relearning after a generation of prices being held down by various forces, including globalization, which the pandemic may have eroded.

“Each of these central banks have been operating within some sort of risk management framework and really since the financial crisis (2007-2009) … the race was who was going to outperform the other” in order to sustain growth and economic growth. employment in a low and even falling price environment, said Ed Al-Hussainy, senior rates analyst at Columbia Threadneedle. “Now it’s the other way around… The risk of error has moved across the street,” in the form of inflation that threatens to stay higher and take with it public expectations of wages and prices.

BLINDLY

Critics say central banks themselves are responsible for keeping interest rates too low for too long and printing too much money for the economy to absorb – especially an economy in which the supply of goods and services has suffered its own setbacks.

Central bankers say much of the current price shock is beyond their control, with inflation made more intense and persistent by events like the war in Ukraine or the still uncertain return of China to its place in the global supply chain for goods.

Whatever the causes, the impact was hard felt by households. Blinded by rising food and energy prices which they believe will be temporary, confidence has begun to erode that central banks will soon hit their typical inflation targets of 2% – a worrying development that began to shape central banks’ own reactions.

After the Fed unveiled its steep rate hike on Wednesday, Chairman Jerome Powell was candid in linking historical action to fear that the Fed will lose the battle in the shaping public expectations on inflation.

Some economists minimize these expectations, measured in household surveys, as being too sensitive to gas and food prices, which are excluded from the “core” inflation trends that are generally given importance in setting monetary policy.

But “headline inflation is what people are going through,” Powell said at a press conference after the political decision. “They don’t know what ‘core’ is. Why would they? They have no reason to. So expectations are very much in jeopardy” the longer headline inflation remains high.

“Central banks have persuaded themselves that longer-term inflation expectations are the main thing,” and have been bolstered by surveys showing that households expect inflation to fall in coming years, said Karen Dynan, a non-resident senior researcher at the Peterson Institute of International Economics and a teacher at Harvard University. But “people are also looking back, and there’s inertia. They’re thinking about wage and price changes that help them keep up,” and are starting to demand them in ways that drive up prices and prices. wages.

If households are becoming less and less confident, politicians are also taking notice.

Bank of Canada Governor Tiff Macklem has faced calls for his impeachment, and the central bank has promised a public review this summer of its flawed inflation forecasts. Australia is planning a review of central bank operations after the Reserve Bank of Australia’s misinterpretation of inflation led it to start raising rates in May after saying until the end of last year that increase in borrowing costs were unlikely until 2024.

Powell next week will testify twice before U.S. congressional lawmakers as part of its regular semi-annual monetary policy updates. Sessions will likely focus on high threat inflation and what has become the central question as interest rates soar and key markets begin to slow: how much worse will it get?

Maintaining central bank independence “was easier when central banks were moving forward — not when a situation was deteriorating,” said Vincent Reinhart, a former Fed official who is now chief economist at Dreyfus and Mellon. He noted that the collective missteps occurred during “the relatively easier part of the tightening period”, when rates have been rising from near zero and the price to pay in terms of slower economic growth and higher unemployment is not yet apparent.

“What happens when you’re closer to the destination…but the destination is much less popular. That’s where they’re headed.”

GRAPH-Central banks opt for shock and fear to control inflation

(Reporting by Howard Schneider Additional reporting by Julie Gordon, Leika Kihara, Sam Holmes, Balazs Koranyi and Wayne Cole Editing by Paul Simao)

((howard.schneider@thomsonreuters.com; +1 202 789 8010;))

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