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Central Banks Still Love Inflation

Posted on June 10, 2022


By Ryan McMaken.

The Bank of Canada on Wednesday raised its key interest rate (known as the overnight rate target) from 1.0% to 1.5%. This is the second fifty basis point increase since April and the third increase in the target rate since March of this year. Canada’s target rate had been stable at 0.25% for twenty-three months, after the bank cut its target rate from March 2020.

As in the United States and Europe, inflation rates in Canada are at multi-decade highs, and political pressure on the central bank to be seen as “doing something about inflation” s ‘intensify.

The bank follows much the same rules as the Federal Reserve when it comes to letting the target rate rise in response to price inflation. The bank’s official stance is that it may resort to very aggressive rate hikes in the future in order to meet the 2% inflation target.

As in the United States, it is important that central bankers give the impression of being hawks, even if their real measures are extremely moderate.

The world’s central banks are still committed to monetary inflation

However, despite their lack of real action, Canada’s central bankers are relatively radical when you consider the major central banks of the world. With a still very low target rate of 1.5%, Canada’s central bank has set a higher rate than the central banks of the United States, United Kingdom, Eurozone and Japan. Indeed, in the case of the European Central Bank and the Bank of Japan (BOJ), the rise in inflation has still not led to an increase in the target rate above zero.

  • Federal Reserve: 1.0%
  • European Central Bank: -0.5%
  • Bank of England: 1.0%
  • Bank of Japan: -0.1%

Additionally, the ECB and BOJ have not budged on their sub-zero target rates for many years. Japan’s rate has been negative since 2016, and the European Union’s (EU) has been negative since 2014.

The Bank of England (BOE) recently raised its target rate to 1%, which is the highest rate for the BOE since 2009.

In the United States, the Federal Reserve raised its target rate to 1%, the highest rate since March 2020.

However, it is clear that neither of these central banks is ready to deviate from the policies of the last twelve years or so, during which the policy of ultra-low interest rates and quantitative easing have become policies perennial.

The Federal Reserve has been tough on inflation, but so far has only dared to raise its target rate to 1% when inflation is close to its highest level in forty years.

The Bank of England apparently suffers from the same problem, as Andrew Sentence of the British daily pointed out The Times :

There is a serious mismatch between inflation and the level of interest rates in Britain. The rate of consumer price inflation measured by the CPI is now 9%, four and a half times the official target rate of 2%. The Bank of England expects CPI inflation to hit double-digit levels by the end of the year… The older measure, the retail price index (RPI), which is still largely used, is already posting a double-digit inflation rate (over 11%). Yet the Bank’s official rate was raised to just 1%, up just 0.9 percentage points from the near-zero rate recorded during the pandemic.

This discrepancy is not limited to the UK. In the United States, where inflation is currently 8.3%, the official federal funds rate is also just 1%. And in the euro zone, where inflation is 8.1%, the European Central Bank has not raised interest rates.

In other words, even with these small rate hikes we’re seeing in the US and UK, the Fed and the BOE aren’t as behind the times as the ECB, which hinted at the end of May that it had begun to consider curbing its easy money policies. But in typical central bank parlance, that means rolling out small changes several months from now.

Specifically, ECB President Christine Lagarde said:

Based on the current outlook, we are likely to be able to exit negative interest rates by the end of the third quarter.

Translation : “We may do something in five months”.

Anticipating the obvious response to this lack of action, Lagarde also insisted:

We are in a very different situation than the United States and we are actually perfectly on schedule and not behind.

Meanwhile, the Bank of Japan shows no sign of easing its moderate policy. Although the yen is in the midst of a historic fall against the dollar and the euro, BOJ Governor Haruhiko Kuroda has made it clear that he does not see any changes.

A strong dollar by default

This is all good for the dollar, and as we have seen in recent weeks, the “strong dollar” talk has returned as other major central banks make their own fiat currencies look even worse than the dollar. Of course, it is quickly devalued, but not as much as the yen or the euro.

Unfortunately, this gives the Fed in the United States even more leeway to conduct inflationary monetary policy. In fact, we have even begun to hear complaints about this “strong dollar”, as exporters, high-flying economists and central bankers often do who think that a weak dollar helps the economy.

The biggest danger here could be the adoption of an updated version of the Plaza Accords of the late 1980s, designed to weaken the dollar. If the weak dollar supporters win this fight, we will see a continued downward spiral in the dollar’s purchasing power, all justified by the “problem” of an overly strong dollar relative to other currencies. Weak dollar supporters are already working on it.

In the short term, however, the dollar is highly unlikely to be the first domino to fall if the world is heading into a sovereign debt or currency crisis. A crisis could actually trigger a flight to the dollar and to competing currencies. Ordinary people, however, will continue to face the wrong options: continued high price inflation with moderate wage increases – meaning lower real wages – or a recession that brings inflation down. (both price inflation and monetary inflation) but increases unemployment. Finally, there could be stagflation, with both a slowing economy and high price inflation. None of these likely options is good news.

Policy rates

Federal Reserve: Federal funds rate

Bank of England: official bank rate

Reserve Bank of Australia: spot rate

Bank of Japan: overnight call rate (observed); (target rate)

Bank of Canada: Target for the Overnight Rate

European Central Bank: deposit facility rate

People’s Bank of China: overnight rate

Translation Counterpoints.

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