In theory, last week’s Fed meeting provided very little in the way of news not already expected by analysts. In practice, there was a warning that monetary normalisation is still on track. Nonetheless, the start of the Fed’s balance adjustment – previously predicted by the market for the September meeting – is now being considered as happening in a “relatively short” space of time compared with in “a very short time.”
It’s important to take these nuances into account. The central banks’ communication policy is key at these moments, trying precisely to mitigate the risks to financial stability in the short term because of the inevitable monetary normalisation. But, on the other hand, in the knowledge that in the medium and long-term financial stability needs to combat the risks of a monetary policy which has been too expansive for too long a period. This is what ECB council member Sabine Lautenschlager said a few days ago: “as time passes, the positive effects of an expansive monetary policy are fewer and risks increase…it’s important to make the decision at the right moment.” But how do you know when the moment is right?
Lautenschlager herself said that a clear path of inflation towards the target 2% level, something which she said has not yet happened, would mark the start of the process. So what’s important is to anticipate this moment. A strategy has to be designed to carry out the adjustment when it’s necessary, starting from the premise that the effectiveness of monetary policy lies precisely in its preventive nature. If you think about it a little, it’s not so different from the Fed’s core message.
The euro’s recent appreciation, an accumulated over 3% in barely three months, has led many economists to lower their inflation forecasts. But the most recent data, such as the Eurozone July CPI released yesterday, shows a greater resistance than expected. While headline inflation in the region remained at levels of 1.3%, the core rate rose one-tenth of a percentage point to 1.2%. The level of core inflation in the quarter is the highest since end-2013.
And this puts another subject for debate on the table: many of the expansive monetary measures were justified as exceptional precisely because of the existence of deflation risks. Now the credibility of the central banks’ management would be called into question if they justified keeping these measures in place despite there being no risk of deflation because inflation is not rising.
There is a phrase which says the markets are always right, with the information at their disposal. And the markets are discounting that in the next few months we will see greater certainty in monetary normalisation strategy. In Europe, for example, we don’t talk about a hike in the official interest rates. But it might be necessary to eliminate measures which are clearly distortionary, like the negative rate on deposits. The start of the Fed’s balance sheet adjustment can also provide the rest of the central banks with information on the reversion of quantitative measures. Little by little. But without hesistation.