Steady as she goes at the European Central Bank. Ditto for the Bank of England. And now, this morning, we learn that the Bank of Canada is saying no to raising interest rates too. Do we smell a trend here?
Yes, if you’re inclined to exclude the Federal Reserve from your banking survey. The Fed, of course, has raised Fed funds nine consecutive times over the past year, with the latest hike of 25 basis points (the prevailing standard thus far) coming on June 30.
Elevating the price of money has become a distinctively American pastime in monetary circles of late. Whether it’s also the right thing to do in managing a nation’s currency seems to be open to debate.
The Organization for Economic Co-operation and Development finds no reason to doubt the ECB’s policy. “The recovery has been sluggish thus far and inflation has responded little to widening slack,” the OECD observes in a new economic survey of the euro area published today. “It would seem reasonable for the ECB to hold its rate stable as long as the outlook for price developments remains in line with price stability over the medium term, although policy would need to act if the inflation outlook were to change.”
Continental Europe’s economy is decidedly weak, at least relative to the U.S. The big three euro economies—Germany, France, and Italy—are all growing at rates substantially below America’s. That translates into real annualized GDP advances of less than 2%. In fact, in Italy, recession has reared its ugly head by way of the slight contraction in the country’s economy in the first quarter.
Meanwhile, the higher rate of GDP expansion in the U.S. accompanies a higher rate of inflation. A coincidence? Perhaps not. The United Kingdom posts a relatively strong rate of economic expansion compared to its national neighbors across the Channel, and England also suffers a materially higher inflation rate. In fact, consumer price inflation rose to a seven year high last month, reports the Financial Times.
The counter argument that higher inflation invariably infests stronger economic growth resides in China, where so many new economic standards are being forged. The Middle Kingdom’s real annualized rise in GDP exceeded 9% in the first quarter while consumer prices were rising by less than 2% according to the latest statistics for May 2005.
Back in the West, one dismal scientist assessing the mounting inflationary tide in the U.K. attributes the trend to the bull market in energy. “The current situation with oil prices not falling much below $60 a barrel is creating inflationary pressure,” Kenneth Broux, an economist at Lloyds TSB Group Plc in London, told Bloomberg News today.
Presumably, the Fed agrees… to an extent. But the banking mavens elsewhere need more convincing. The ECB, for instance, finds cover for keeping rates low by pointing to the Continent’s stumbling economy.
Back in the U.S., the balancing act of promoting economic growth and keeping a lid on inflation has, for the moment, been achieved. Can the central bank keep up its highwire act going forward? Perhaps, although the latest Blue Chip Economic Indicators newsletter suggests suggests there could bumps along the way. On the one hand, the prediction of real economic growth for 2005 was raised again, to 3.6% from 3.5% previously, the publication revealed, according to Reuters. But inflation forecasts were elevated as well. As Reuters reports of Blue Chip’s latest published prognostications: “Forecasters believe the Consumer Price Index will climb 3.0 percent this year, the largest rise since 2000, up from 2.9 percent forecast a month ago. The inflation forecast has been ratcheted up four months in a row, from just 2.5 percent in March.”
Curiously, the rate of increase for consumer prices in the U.S. dropped sharply in May to an annualized advance of 2.8% from 3.5% in April. Is that a sign that inflation’s threat is receding? Absolutely, suggests Paul McCulley, managing director of the giant bond shop Pimco, in his latest missive on things monetary. There is no conundrum, he declared, referencing the oft-quoted word that Fed Chairman Greenspan deployed to describe the drop in long rates during a time when the central bank was raising short rates. “The fact of the matter is that there is no conundrum in what long rates have done since the Fed started tightening, if you look at what both the ISM Index and long rates did in the year before the Fed started tightening!”
What does McCulley see in ISM? Quite simply, it’s the “single-best statistical indicator of the direction and pace of manufacturing activity in America, which is the single best cyclical indicator of the direction and pace of Fed policy,” he advised. Although manufacturing represents a smaller and fading share of the American economy, it’s still important because it drives the business cycle, which in turn casts a long shadow over Fed policy, he explained.
The bottom line, McCulley offered: “Bonds don’t wait for the Fed, but rather take their cue from the ISM Index.” And on that score, the ISM cue has been issuing signals for more than a year that interest rates need to fall. Declining to the low 50s in recent months, from the low 60s in the first half 2004, ISM explains what Greenspan can’t on the matter of the price of money. Or so McCulley told us. What then to make of the latest ISM report, with an unexpected jump in the index to 53.8 from 51.4? Another anomaly or just a pause in the accumulating evidence of economic slowdown?
Hold that thought. This, after all, is a week with fresh inflation news. Import prices, consumer prices, and wholesale prices for June will be revealed this week. Who, in other words, has monetary jam on their face? New clues await.