Japanese probe missions SLIM and the American module Odysseus They showed this year how difficult it is to achieve a soft landing on the Moon. The term from the space race was adopted by the Federal Reserve to refer to the way to rein in inflation without causing a recession that triggers a sharp rise in unemployment. In the economy, it is almost as difficult to achieve as on the Moon. It has been the objective of the president of the Fed, Jerome Powell, for more than two years. Now that inflation has lost altitude, the fear is that the ship will run out of fuel. This entails a change of cycle in monetary policy, as confirmed this weekend by the Jackson Hole symposium. Powell will soon follow the path taken by his colleagues at the European Central Bank (ECB) and the Bank of England: that of rate cuts.
“The time has come,” were the words of the US central bank chief on Friday to mark the turning point. It is almost a commitment that he will lower the price of money at the meeting on 18 September. The long-standing president of the Bundesbank, Karl Otto Pöhl, used to say that inflation is like toothpaste: once it is out of the tube, it is very difficult to put it back in. After three years, Powell believes he has almost achieved it. “My confidence that inflation is on a sustainable path back to 2% has increased,” he said on Friday.
The symposium has analysed the extraordinary nature of the latest global inflationary phase, in which demand distorted by stimulus programmes and savings accumulated since lockdown collided with the strangulation of supply due to supply chain bottlenecks and the war in Ukraine, among other factors. Across the world, that phase, which has been much less transitory than central bankers initially expected, seems to be behind us.
With the notable exception of the Bank of Japan (where rates are rising), the world’s major central banks appear to be aligned in lowering the cost of money. The ECB appears set to lower rates again in September, judging by statements made by some of its board members at Jackson Hole. Finland’s Oli Rehn said that the process of disinflation in the euro zone is “underway”, while “growth prospects in Europe, especially in the manufacturing sector, are rather moderate”. “This reinforces the arguments in favour of a rate cut in September”, he concluded. Mario Centeno, governor of the Bank of Portugal, said it was an “easy” decision, given the data on inflation and growth, although his Austrian colleague Robert Holzmann expressed his reservations and assured that the cut is not a “foregone conclusion”.
At Saturday’s session, Philip Lane, a member of the ECB’s executive board and the only one speaking on the programme, tried not to get too involved. “There has been considerable progress towards achieving the primary objective of ensuring that inflation returns to the target” of 2%, He said in his speech, but he qualified that this return “is not yet assured”. He gave a mixed reception: “The monetary policy stance should remain restrictive for as long as necessary”, he said, and then stated that “a path of interest rates that is too high for too long would generate inflation that is chronically below the medium-term objective and would be ineffective in minimising the secondary effects on production and employment”.
For his part, Andrew Bailey, Governor of the Bank of England, was shown in his symposium speech “cautiously optimistic that inflation expectations are better anchored.” Although he warned that it is “too early to declare victory,” his words suggest that he will also continue to lower rates, as he did at the beginning of the month for the first time in three and a half years. Central banks in Canada, New Zealand and China are also easing monetary policy after successfully containing prices.
Lessons learned
In this phase of high inflation, Powell has repeatedly recalled what happened to Arthur Burns, chairman of the Federal Reserve in the 1970s. He was tolerant of inflation, which became entrenched in the American economy for a decade. It was his successor, Paul Volcker, who put a stop to prices with aggressive rate hikes that triggered a recession. Powell, an admirer of the latter, was willing to pay that price.
Two years ago, also in Jackson Hole, he said it would probably be necessary to inflict “some pain” on families and businesses, but that he would not give up on his efforts to control inflation and that, until the job was done, he would “keep at it.” (Keep at it, Keep with it, (This is the title of Volcker’s autobiography.) Last year, at the same symposium, he again brought out his hawk’s claws, predicting long-term highs. Now, “the time has come.”
The US Congress has given the Federal Reserve a dual mandate to seek price stability and full employment, unlike the ECB, which has only the former as its guiding light, at least in theory. After three years in which employment was pulling strongly and Powell was concerned about inflation, he is now changing tack. “The upside risks to inflation have diminished. And the downside risks to employment have increased,” he said. Inflation has fallen below 3% for the first time since March 2021, while unemployment has climbed almost one point in a year, to 4.3%, although it remains at historically low levels.
“Our main takeaway from Federal Reserve Chair Jerome Powell’s speech at Jackson Hole is that the central bank will not tolerate further weakness in the labor market,” analysts at Oxford Economics note. “This dovish stance provides a fairly clear anchor for the labor market and increases the chances of more aggressive monetary policy easing,” they add.
A gradual reduction
Barring a negative surprise in the jobs data in the coming weeks, Fed members are leaning toward a measured approach to rate cuts, which would include a 0.25-point cut in September, followed by others in November and December. Boston Fed President Susan Collins said she expects “a gradual and methodical pace” of cuts, and Philadelphia Fed President Patrick Harker said the same: “I think a slow and methodical approach to lowering rates is the right path to take.”
Powell, however, did not use the word “gradual” but instead underlined the “ample scope” he has to respond to the weakening labor market, leaving the door open for a more aggressive response: “We will do everything possible to support a strong labor market as we continue to move toward price stability,” he said on Friday. “The current level of our policy rate gives us ample scope to respond to any risks we may face, including the risk of an unintended further weakening of labor market conditions,” he added.
“It will depend on what the upcoming data say,” Atlanta Fed President Raphael Bostic said Friday. “We will have to make a bigger move” if unemployment rises further, he added, as reported by Bloomberg. The market gives a 76% chance for a 0.25 point cut and a 24% chance for a 0.50 point cut. according to CME’s FedWatch tool. At the Fed’s September meeting, members will also release a new set of economic projections and indicate where they expect the policy rate to be at the end of each year through 2026.
The United States has so far avoided a recession that many saw as inevitable, and Powell remains confident that rate cuts will prevent one: “With appropriate moderation of monetary policy, there is good reason to think that the economy will return to 2% inflation, while maintaining the strength of the labor market,” he said on Friday. Across the ocean, the governor of the Bank of England agrees with the thesis: “The economic costs of reducing persistent inflation – costs in terms of lower output and higher unemployment – could be lower than in the past,” he said, something “more in line with a soft landing than with a recession-induced process.”
Time will tell whether central banks manage to avoid a recession or whether they are late. Philippe Waechter, chief economist at Natixis-affiliated asset manager Ostrum AM, supports the first theory: “They intervene in time, even if GDP and consumption data do not yet show a pattern consistent with a recession. The role of central banks is to prevent the situation from getting out of hand.”
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