US Federal Reserve chairman Jerome Powell and the world’s top chief economists are both warning that global inflation is likely to stay around much longer than markets are anticipating.
Powell is adamant that interest rates will have to stay high — and maybe increased – until the inflation reduction job is done.
That’s not the message markets wanted to hear.
Both Powell and Reserve Bank governor Philip Lowe are traditional central bankers who do not want their legacy to be tarnished by embedded high inflation.
Fighting inflation is far more important to both central bank chiefs than the risk of a severe downturn, so both this week lifted their cash rates by a quarter of a per cent to maintain the pressure on inflation via reducing consumer spending and economic activity to curb price rises.
In the US, Powell is concerned about instability in the American banking system so is promising a pause in interest rate hikes but is warning that the pause may mean that it will take longer to reduce inflation.
He did not take further interest rate hikes off the table – shares fell.
The World Economic Forum Survey of top economists showed they believe the central banks will struggle to reach their inflation targets because if interest rates stay high for too long it will endanger financial sector stability.
That means the central banks’ low inflationary targets would not be met.
Powell hopes an interest rate pause will help re-establish financial stability, but he clearly recognises the dangers.
In Australia, the RBA’s latest rate increase decision bruised the egos of a lot of Australian economists.
They did not understand the priorities of Lowe, which I detailed last month.
But the community reaction was severe, so Lowe’s replacement will be under huge pressure.
On the surface both the US and Australia are in similar positions with both economies slowing with signs that, while inflation is moderating, it is still very high.
But in Australia workers, including those at universities, are now pushing for wage rises and are being encouraged to do so by some of the sentiments being expressed by government ministers.
If a sufficient portion of the workforce succeed, then interest rates will stay high in Australia for much longer than is being anticipated by the market.
But Australia is in a unique global position because leading up to the current crisis Australian banks went on an unprecedented lending spree, so we have a huge mortgage belt that simply that can’t make ends meet and is facing much higher interest rate cash outflows in coming months.
Australian enterprises are just starting to feel the spending impact, but it will become much more severe.
The CBA believes that severity will be much will be worse than most other countries and will drive down inflation and interest rates.
But not everyone agrees.
As my colleague David Ross highlights, Macquarie Group chief economist Ric Deverell points out consumer spending and employment is holding up, so the higher rates may take longer to reduce inflation both in Australia and internationally.
That’s essentially the Powell message from the US and is the fear of Philip Lowe.
If inflation does not respond to the current set of rate rises, then both our RBA and central banks around the world will either have to leave their current high interest rate level in place for a much longer or, more likely, increase interest rates further.
Under that scenario, there is a high likelihood of recessions.
Deverell says that inflation is going to be “much stickier on the way down”, resisting the rate rises thrown out by central banks.
“The longer the economy is resilient and the more the Fed has to hike, the greater the chance you’ll have a harder landing … there is a “60 per cent chance we’ll have a plain vanilla recession in the next six months”, he says.
Of course, in Australia, there is a second difference to other countries.
As I pointed out yesterday, we are substantially boosting our migration at a time when our building industry has been decimated and will not be able to create the dwellings required at anything like current costs.
We could have a spike in house prices at the same time as an economic downturn, which will make it dangerous for the RBA to reduce interest rates in response to that downturn.
If that happens, then Deverell’s prediction of a recession looks highly likely to come to pass.
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