Hawk alert
From The Economist print edition
Central bankers are talking tough. They may be talking themselves into trouble
YOU can hear the talons scratching. Ben Bernanke, chairman of the Federal Reserve, first adopted a hawkish tone on June 3rd, lamenting the weak dollar's part in an “unwelcome” rise in inflation. Two days later Jean-Claude Trichet, president of the European Central Bank, stunned financial markets by declaring that the ECB may raise short-term rates at its next meeting in July. Then Mr Bernanke swooped once more. In a speech on June 9th he played down the news that America's jobless rate had risen in May by half a percentage point, to 5.5%. He argued that the risk of a nasty economic downturn had fallen and he promised that the Fed would “strongly resist” any rise in people's expectations of future inflation. As central banks from Canada and Britain to Vietnam and India have shown their claws, bond markets have been in turmoil (see article). Investors have concluded that short-term interest rates are heading up, and fast.
About time too, you might say. With falling odds of a financial-market catastrophe and inflation uncomfortably high (and set to rise higher) the balance of risks is shifting. If central bankers have learnt anything over the past three decades, it is to make sure that people do not start to think long-term inflation rates will creep up. Words—including a certain anti-inflationary swagger—are valuable weapons in the modern central banker's arsenal.
All that is true. But talk soon loses its power to convince unless people believe it will be backed up with action. The problem today is that the distance between talk and action differs dramatically between the Fed and the ECB.
Birds of a feather
Granted, the two central banks survey different economic and monetary landscapes. America is close to recession and real short-term interest rates are negative. The euro zone has a stronger economy but much tighter monetary conditions (the ECB has kept short-term rates unchanged at 4% throughout the credit crisis). Both central banks face a similar problem: how to deal with inflation that is being pushed up by commodity prices, particularly for oil. Both are determined to avoid the mistakes of the 1970s, when loose monetary policy transmitted the oil shock into the economy, setting off a spiral of rising wages and prices. But the central banks disagree as to the amount of insurance they need to stop that happening.
The European Central Bank reckons that a slower economy will not be enough to stop prices rising. Although output has been surprisingly resilient so far, most forecasters expect a slowdown in the second half of the year. But with unemployment low and headline inflation high, the ECB—with its single mission to keep inflation at or below 2%—is worried about knock-on effects. Even though oil is the main culprit and long-term inflation expectations have not moved much, the ECB's desire to pre-empt persistent inflation points clearly to higher interest rates in July.
The Fed seems much less likely to raise rates. Despite some warning signs—on one measure, for instance, consumers' expectations for long-term inflation are at a 12-year high—wage growth is slowing, and average pay cheques are falling sharply in real terms. There is no whisper of a wage-price spiral. What is more, house prices are still tumbling and the financial hangover from the credit crunch is not over yet. The risks to growth, as Mr Bernanke admits, are on the “downside”. And, for better or worse, the Fed is charged with caring about both full employment and stable prices. Add in the politics of raising interest rates just before a presidential election, and the odds are that the Fed's talk remains just that.
A wide transatlantic gap between rhetoric and action is unfortunate—and bodes ill for the Fed's credibility. After the Fed's rapid, pre-emptive loosening to a federal funds rate of 2%, financial markets will be watching to see whether it is correspondingly prepared to tighten again. Mr Bernanke has made his job all the harder by adding the dollar to the mix. If the ECB tightens and the Fed does not, the dollar is likely to weaken against the euro—exactly the opposite of what Mr Bernanke last week implied he wished to happen. For the time being, the dollar is up and oil prices down. The hawkish rhetoric seems to be working a treat. But unlike real talons, mere words will not leave a lasting mark.
