Stephen Miller

I have described the task facing the Fed and ECB is akin to a circus high wire act: charting a path between getting inflation back toward target without tipping the economy into recession.

The Fed, however, is doing so with a balancing pole and with eyes wide open.  The ECB on the other hand is attempting the same without a balancing pole and blindfolded.

The most recent April core PCE inflation measure (the measure favoured by the Fed) is at 4.9 per cent, well above the Fed’s target of around 2%.   However, there is some evidence of a trend deceleration in the inflation ‘pulse’. The 3-month annualised number was at 4.0%, down from 6.0% as recently as December and not that different from the Fed’s forecast of 4.1% for the year to December 2022. 

That seems to give some vestige of credibility to the sentiments expressed in the May FOMC meeting minutes that the Fed plans to get to neutral expeditiously, but thereafter may have some breathing space. 

Certainly the Fed and the US are not out of the inflation mire but progress is tangible.

It is a different story when it comes to the ECB.

The picture painted by the release of European provisional inflation numbers is troubling. The Harmonised Consumer Price Index (HCPI) came in at 8.1 per cent, four times the ECB’s 2% goal.

Germany’s CPI inflation rate at 7.9% is the highest since December 1973 when the then West Germany also recorded a rate of 7.9 per cent. Prior to that we have to back to the early post-war period to find a higher rate.   

The inflation genie looks well and truly out of the bottle and with an accompanying massive squeeze on real incomes, the threat of stagflation is a clear and present danger.

Yet the ECB has demonstrated an egregious reluctance to engage in any meaningful shift in policy from “emergency” levels. 

It will likely only announce the end of QE at its next meeting on 9 June. 

ECB President Christine Lagarde has only recently abandoned her usual studied circumspection to foreshadow two 25bp increases in July and September. 

Even then Lagarde has revealed a reluctance to acknowledge the depth of the inflation problem and continues to imply that it is more transitory in nature. Lagarde insists that the ECB was “facing a very different beast” to the Fed. That might be correct, but the May inflation numbers suggest that it might not be different in the way Lagarde sees it. 

Indeed, Lagarde’s comments on July and September rate hikes did not seem to indicate a Damascene shift in view, but more an attempt to stave off growing calls among the ECB’s more hawkish wing and from markets to keep the option of a 50bp hike at either the July or September meetings. 

Lagarde has a difficult job. The ECB is cursed with an institutional inertia in its decision-making processes. That same institutional inertia severely constrains its ability to flexibly employ fiscal measures which might have taken some of the burden of monetary policy early in the pandemic. 

The calls for a 50bp increase are getting louder with the Austrian Central Bank Governor Robert Holzmann overnight repeating his call for a hike of that size, saying a lack of “decisive action” now would risk expectations about the path for consumer prices becoming unanchored, requiring tougher measures later on that could trigger a an even more disruptive economic dislocation.

ECB meetings are about to get interesting and Lagarde will need to harness all of her deft diplomatic skills and the authority she carries as the President to see her view prevail. Let’s hope that view is the right one.

I have my doubts.

Bank of Canada hikes 50bps to 1.50%, signals aggressive action to come

In a widely anticipated move, the Bank of Canada announced a 50bp increase in its policy rate to 1.50%. That was the first occasion on which the Bank of Canada has raised the policy rate by 50bps since the inception of the current process of fixed decision dates back in 200. Moreover, the Bank warned that it might need to act “more forcefully” as if needed as the “risk of elevated inflation becoming entrenched has risen.” Governor Macklem had previously presaged “forceful” action to combat inflation.

Canadian April CPI exceeded expectations with the headline rate coming in at 6.8% yoy and core at 5.7% yoy (versus expectations of 6.7% and 5.4% respectively) and the Bank appeared to concede that inflation is rising faster than their April forecasts and “will likely move even higher in the near term before beginning to ease.”

Markets are pricing in another half-point increase at the July 13 meeting, before slowing the pace of tightening in the second half of this year. The terminal rate is seen at a little over 3%.

The Bank has in the past suggested that the neutral policy rate is somewhere in the 2-3%. However, the aggressive nature of the commentary surrounding last night’ move raise the question whether the Bank needs to increase rates beyond the neutral range and into restrictive territory given the stubborn persistence of inflation. 

On that basis, there would appear to be upside risk to that 3% mark.

National Accounts suggest RBA need not be in a rush

Yesterday’s release of the March quarter national accounts does not seem to suggest that the RBA need to be contemplating a more aggressive path. 

On the inflation side, significant price pressures were evident, with the household consumption deflator up 1.5% and the domestic demand deflator up 1.4%, both the strongest quarterly rise since 2000. That, however, is old news.

Wages growth as measured by average compensation per employee remained modest at 2.2% yoy, although average hourly earnings were up sharply. The wage numbers are little difficult to interpret given COVID induced employee absences in the quarter. It is still somewhat of a puzzle as to why wages aren’t more visibly accelerating given tight labour markets. At this stage I’m putting it down to inertia in the official data as anecdotal evidence suggests wage growth is accelerating – as it should given tight labour markets. Nevertheless the puzzle should be acknowledged.

Having said that the numbers are not enough to forestall a further increase of 25bps in the policy rate when the RBA meets on 7 June. What they do mean is that unlike other developed country central bank there is a limited need to consider ‘super-sized’ increments of 40 or 50bps. 

Coming up: US non-farm payrolls

US non-farm payrolls, ADP employment data as expected

According to Bloomberg, market expectations for US May non-farm payrolls are for an increase in employment of around 325k (from 428k in April) and a one-tenth decline in the unemployment rate to 3.5% from 3.6%. Friday’s report is potentially difficult to interpret as any disappointment in jobs growth may have as much to do with supply-side issues as with any deficiency of demand.

The employment sub-components of recent ISM manufacturing and non-manufacturing have fallen even if the reports themselves note that businesses continue to report labour supply constraints. That suggests that supply constraints may account at least for some of any headline employment weakness.

The notion that supply constraints may be responsible for any headline employment weakness is lent support both by the April (Job Openings and Labor Turnover (JOLTs) report released overnight which showed an elevated number of vacancies at 11.4m, although that was down on the March record of 11.9m. That report also noted that ‘quit’ rates remain close to record highs, and lay-offs at record lows. While there have been anecdotal reports of stronger wage growth, growth rates in average earnings have failed to keep up with the rate of inflation.

The average earnings number within the overall non-farm payrolls report will likely therefore be closely watched, with the market expecting an annual increase around 5.2%. That would be down from 5.5% in April and may lead to some fuelling of the notion of a terminal policy rate at no greater than 3%. 

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