Peak in the clouds
- The US inflation peak remains elusive, calling for another jumbo Fed hike this week (we expect 75 bps)
- We discuss Maurice Obstfeld’s call for a more internationally coordinated monetary policy
- The reaction of G. Meloni to the EU/Hungary spat needs to be watched carefully
The US inflation peak remains elusive. While the “exogenous factors” of inflation continue to abate – US import prices excluding oil are now growing by less than core consumer prices – domestic pressure continues to accumulate. The softening of the US labour market which had emerged in late spring has given way to impressive resilience. The decline in long-term inflation expectations should bring some comfort to the Fed, suggesting the central bank has regained its full credibility, but their research suggests that the still-elevated short-term expectations matter more for wage and price dynamics. All this calls for another jumbo hike this week. Some observers are now calling for 100 bps. It may well be an option, but even with a 75-basis points hike – our baseline – the policy stance will reach restrictive territory. This should call for a modicum of prudence.
The accumulation of oversized hikes creates the impression of “race to the peak” across central banks. Maurice Obstfeld’s called for a more internationally coordinated monetary policy, to reduce the risk of excessive tightening. We agree in principle but in practice, such coordination would be truly efficient only if exchange rate management was part of the package. Even in a coordinated approach, the respective quantum of tightening would likely depend on the position of each economy in the cycle. Given the US overheating, in contrast with the Euro area, a significant rate differential would remain between the two currencies. The ensuing weakness in the euro, fuelling imported inflation, would still tempt the ECB into “hiking too much”, jeopardizing any internationally pre-agreed pace of tightening. We are not holding our breath on the chance to see such grand bargain emerge any time soon.
Finally, we look into the EU Commission’s recommendation to suspend part of the structural funds to Hungary. The reaction of the likely winner of the Italian elections this week casts a light on the possibility to see Rome aligning more with the “combative” Eastern member states. This won’t help the Union make further progress.