03/03/2023 Former Bank of Japan Governor Shirakawa writes in an
article for the IMF on inflation targeting, urging “now that we know its limitations,
the time is ripe to reconsider the intellectual foundation on which we have relied for the
past 30 years and renew our framework for monetary policy“. So, does this mean we have
to accept 3-4% inflation? Maybe, we shall see, Shirakawa himself says he is ‘sceptical’ of
adopting a higher inflation target. But it’s not beyond the realms of possibility that the
Fed and others decide that forcing the issue on 2% might not be worth the pain. As Shirakawa
says: “Inflation targeting itself was an innovation that came about in response to the
severe stagflation of the 1970s and early 1980s. There is no reason to believe it is set in
stone.” Why does this matter? If you accept higher inflation then you can dial back the
rate hikes. And that could be seen as necessary as inflation is proving so incredibly
stubborn. For gold investors it could be a bonanza – higher inflation, lower rates = lower
real yields. This week saw eurozone inflation remain stubbornly high. The headline CPI
number fell to 8.5%, from 8.6% in the previous month. This was less of a decline than
anticipated, whilst core inflation worryingly jumped from 5.3% to 5.6%. The smart rise in
the core reading only makes it more likely the European Central Bank follows up an expected
50bps hike in March with a further half point move in May. Everyone and his dog now piling
into 4% terminal rate consensus. US inflation has been hotter than expected in the last
couple of weeks and this week saw the ISM manufacturing price paid index jump from a
strongly disinflationary 45.5 to a more inflationary 51.3. That helped drive the 10yr
through the 4% barrier this week. Meanwhile we’ve had some mixed messaging from the Bank of
England – for a change! Andrew Bailey, the governor of the Bank of England, signalled
interest rates may have peaked, or did he? After 10 straight hikes, he said there was not
necessarily an urgent need to do more: “At this stage, I would caution against
suggesting either that we are done with increasing Bank rate, or that we will inevitably
need to do more…Some further increase in Bank rate may turn out to be appropriate but
nothing is decided. The incoming data will add to the overall picture of the economy and the
outlook for inflation, and that will inform our policy decisions.” Some headlines said
we’re in for more hikes, others said the BoE signalled it could pause. Mixed messages help
no one. We have to see this in context – markets had ramped bets of peak rates from around
4.25% a month or so ago to around 4.75% as a global bond selloff gathered momentum through
February. The last time markets had lofty rate hike expectations the BoE governor was keen
to push back – once they had come down the BoE thought market pricing was more appropriate.
Just coincidence that his remarks came as data showed the UK registered its biggest drop in
house prices in a decade – the ‘British problem’ for the Bank of England raising rates too
far is the impact on the housing market. Bailey has been very keen not to allow the market
to price in too many hikes – that does not mean they are not going to emerge, but I do
believe the BoE’s bias will be to ease later in the year.
Group