Jonathan Marriott, Chief Investment Officer
The speech made by Federal Reserve Chairman, Jerome Powell, at Jackson Hole on Friday was a case in point. He recalled the fight his predecessor, Paul Volker, had with inflation in the 1970s and 1980s who raised interest rates dramatically, despite a recession and high unemployment. By acting aggressively, Powell hopes to prevent a repeat of the inflationary spiral of the 1970s. He made it clear that the priority was to fight inflation even if the economy slows and unemployment rises. Clearly, he agrees with Norman Lamont who said during his time as Chancellor of the Exchequer that high unemployment and a recession were a price worth paying to get inflation down. Inflation today is a global phenomenon and central banks elsewhere will need to be equally determined if the inflation genie is to be put back in the bottle. Next week we will see if the European Central Bank (ECB) is as determined as the Federal Reserve.
Declaring a willingness to fight inflation, therefore risking recession and higher unemployment, may in itself control inflationary pressures. However, a sustained period of higher rates with higher unemployment and recession may be required for inflation to be firmly returned to the bottle it has escaped from. Talking strongly of fighting inflation at all costs may be easier than facing up to the reality of a recession and high unemployment. Whilst central banks are independent, they are appointed and have their mandates set by politicians. On Monday we will have a new Prime Minister in the UK, and in the US, we have mid-term elections for congress in November. No politician wants to go into an election with a recession or high unemployment.
The new Prime Minister will be faced with a cost-of-living crisis and ever-increasing demands for inflation busting pay rises. The two candidates have very different priorities and plans, but whoever it is will have to fight a general election in 2024 against a very difficult economic background. Boris Johnson’s legacy may have been irreparably damaged and how the new leader deals with the coming winter may define their legacy. Similar challenges face Joe Biden with a presidential election in 2024, potentially against Donald Trump, who was a vocal critic of the Federal Reserve while in office.
Whilst the challenges in Europe, the UK and the US are interlinked, they are very different. Many factors drive inflation, however the cutting of gas supplies from Russia has been a particular threat to Europe. Gas prices have soared as supplies have been cut. Whilst the UK is less dependent on Russia it is still subject to global prices. In Europe they have been building significant reserves and in Germany they have taken steps to cut demand. In the UK, there is little storage capacity and as a result we may feel the pinch of short-term fluctuations over the winter more than in other parts of Europe. Whilst the Bank of England talks of inflation peaking around 13%, there are some analysts suggesting inflation will peak at over 20% driven by rising energy costs.
Over the next three weeks we have one central bank meeting after another, starting with the ECB next week, the Bank of England the week after and the Federal Reserve on the 21st of September. Over the last week ECB members have been openly talking of a 0.75% rate increase. Next week we will see how serious they are in fighting inflation. Inevitably central bank policy will remain a central talking point for some time to come.
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