Amidst persistent and excessive inflation, most of the world’s major central banks have sharply raised rates. Some have just shown a willingness to wait and see whether these hikes will suffice to knock inflation down.

In Focus - High Enough?

A boxer delivers a punch and the effect is immediate. A bowler, in contrast, releases the ball and then must watch and wait, hoping the trajectory and spin of her roll will deliver a strike rather than a dreaded 7-10 split.

Central banking is more like bowling. The banks hike their policy rates and apply quantitative tightening as they see fit, then wait to see what happens. How will these short-term policy rates translate into longer-term lending rates, like 10-year bonds or mortgage interest rates? How will businesses alter their investments and hiring in response? And, ultimately, will inflation hit the target?

Over the last couple of weeks, major central banks seemed increasingly inclined to pause and see what happens. The U.S. Federal Reserve, the Bank of England, and the Bank of Japan (BOJ) all decided to wait and see what effect existing policy would have on inflation. The European Central Bank (ECB) increased its policy rates by 25 basis points on September 14.

The chart shows that, for all but the Bank of Japan, rates have risen sharply – a much steeper ascent than we saw from 2003-2007. Yet, the chart also shows that there’s nothing particularly novel about policy rates between 4% and 5.5%. That would be even clearer if the chart were extended back toward the 1970s. This begs the question of whether the current elevated rates are an aberration or a return to the norm, after an odd stretch of unusually loose money (low rates).

The bowling analogy has its limitations. Central banks can heighten the impact of rate hikes by extending their duration and by reserving the right to hike further. The Fed reiterated its guidance that rates were likely to stay “higher for longer,” with the median projection for policy rates showing an increase to 5.6% by the end of the year and a decrease to only 5.1% by the end of 2024.

The Bank of England ended its string of hikes, but the decision was a close one: 5-4, with the minority arguing for an additional hike.
ECB policymakers felt less confident that inflation was under control, suggesting there could be further hikes in the offing.

The BOJ has maintained rates at -0.1%, where they have been since September 2016. The reluctance to hike perhaps reflects decades of combating deflation. The BOJ did take the notable step of relaxing its control of longer-term interest rates, known as yield curve control, in July.

When central banks diverge in their monetary path, the result usually shows up in exchange rates. The BOJ’s softer approach has pushed the yen near 150 to the dollar recently, weakening to the point where the Ministry of Finance has intervened in the past. If the BOJ were to raise rates in October, it could, in effect, relieve the MOF of the task.

None of the central banks expressed satisfaction with current levels of inflation. Instead, to differing degrees, they’re pinning their hopes on the efficacy of policy already under way.

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Today we follow up on recent swings in the energy component of the U.S. Consumer Price Index and what they might mean for consumer demand heading into the fall.

Last week we looked at India’s goods exports.

Economic Developments

The most recent slate of inflation prints showed small improvements from the beginning of 2023, but measures remain well-above the 2% target.

• Euro area headline inflation slowed by 0.1 percentage point from July to an annualized rate of 5.2% in August, its lowest reading since January 2022. Inflation was at 9.1% in August 2022. Core inflation, which takes out energy and fresh food, was even further above the headline number at 6.2%.

• UK headline inflation eased to an annual rate of 6.7% in August, down from 6.8% in July and reaching its lowest rate since February 2022. While lower than August 2022’s 9.9%, the number remains far above the target. Core inflation, which excludes energy, food, alcohol and tobacco, also slowed to 6.2% from 6.9% in the previous month. Falls in inflation were attributed to smaller price increases in accommodation.

• Japanese headline inflation ticked down to an annual rate of 3.2% in August from 3.3% in July, but it was above August 2022’s reading of 3.0%. Compared to the previous month, a slowdown to 8.6% from 8.8% in price increases for foods and acceleration of price decreases for utilities to -12.3% from -9.6% pushed inflation down. Core inflation, which strips out fresh food and energy, was unchanged from July at 4.3%.

• Canadian headline inflation rose to an annual rate of 4.0% in August, after 2-year lows of 2.8% and 3.3% in June and July. The increase was driven by higher energy prices, with gasoline prices growing 0.8%, following a 12.9% deflation in July. Core inflation, which omits food and energy, also accelerated to 3.6% from 3.4%.

Euro area consumer confidence fell 1.8 percentage points to a score of -17.8 in September, continuing the downward trend for the second month after steady increases since September 2022.

U.S. crude oil stocks fell 0.2% in the week ending on September 16th, and gasoline stocks also declined 0.4% during the same period. Compared to the same week in 2022, crude oil stocks were 10.3% lower while gasoline stocks were 2.3% higher. Stocks are at the lowest levels since the early 1980s.

Existing-home sales dropped 0.7% month-on-month and 15.3% year-on year in August. However, the median price of existing-home sales rose 3.9% year-on-year to $407,100. Inventories of unsold existing homes also declined 0.9% from July to the equivalent of 3.3 months’ supply, which was higher than August 2022’s level of 3.2 months.

The most recent releases of flash PMIs indicated stagnant or falling manufacturing output and economic growth, as input costs rise while demand decreases. Note: Readings below 50 indicate a contraction.

• US headline flash PMI inched down to 50.1 in September, following a score of 50.2 in August, driven by falling activity in the services sector. Manufacturing output improved to a reading of 49.7 from 48.5.

• The Euro area headline flash PMI rose to 47.1 in September from 46.7 in August, while manufacturing output was unchanged at a score of 43.4. While decreasing at a slower rate, contraction in the Euro area was attributed to manufacturing production declines in Germany and France.

• UK headline flash PMI fell to 46.8 in September from 48.6 in August, recording the lowest score since January 2021, due mainly to a more severe decline in the services sector. Manufacturing output is still contracting but the PMI reading rose to 44.6 from 44.1, as decreases in industrial production eased.

• Japanese headline flash PMI declined to 51.8 in September, following a reading of 52.6 in August, as growth slowed. Manufacturing output also fell to 48.6 from 48.9, as new manufacturing orders further decreased.

Last week was light on major trade data releases, but in Asia we are starting to see the early effects of export controls on equipment for production of advanced semiconductors.

• Singapore non-oil re-exports fell 8.3% year-on-year in August, after a 10.7% decrease in July. Re-exports of electronics declined 11.6%, following a 3.4% drop in July, although through the first eight months of the year they are 35% above 2019. Non-electronics re-exports were 4.4% below last year’s levels. Singapore is one of the world’s busiest ports and is a key transshipment hub for inter-Asia and intra-ASEAN trade of intermediate and finished goods.

• Japan’s exports were down 1.5% year-on-year in August and 1.7% from July on a seasonally adjusted basis. Semiconductor exports were up 8.1%, but exports of machinery to manufacture semiconductors were down 36.3%. Japan implemented export controls on semiconductor equipment and machinery at the end of July. Measured in units, total vehicle exports, including light vehicles and trucks and buses, rose 26%.

Political Developments

In the OECD’s most recent Economic Outlook Report, expectations for the global economy remain weak, with global real GDP growth projected to be 3.0% (revised upward 0.3% from its previous release) in 2023 and 2.7% (revised downward 0.2%) in 2024. Headline inflation was predicted to continue declining in G20 countries, to 6.0% in 2023 and 4.8% in 2024, which is still above target rates of 2%. Moreover, core inflation remains high, with projected rates of 4.3% in 2023 and 2.8% in 2024 for G20 Advanced economies. Persistent inflation was attributed to price increases in the services sector and tight labor markets, leading the OECD to urge central banks to pursue restrictive monetary policies.

In the Institute of International Finance’s latest global debt monitor report, total global debt grew $10 trillion to $307 trillion in the first half of 2023, reaching a record high. Global debt as a share of GDP also rose 1.8 percentage points to 335.9% in the same period. The increase in debt was mainly driven by higher borrowing costs due to climbing interest rates as a result of tightening monetary policies. The IMF also warned against persistent long-term trends in rising debt last week.

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