Central Bankers fear losing public trust, focus on fighting inflation

The Central bankers meeting at the Jackson Hole symposium shattered traders’ hopes for a reversal in the Fed policy raising interest rates to fight inflation. In fact the Fed’s comment that it is ready to do whatever it needs to bring down inflation made the US markets fall by 4%.

Macro commentary by eToro analyst for Romania, Bogdan Maioreanu

Jerome Powell, the Fed Chair, considers that restoring price stability will take some time and requires using the Fed’s tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth and very likely will bring some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, these will also bring “some pain” to households and businesses. These are the unfortunate costs of reducing inflation, but a failure to restore price stability would mean far greater pain, mentioned Jerome Powell.

It is very likely that Romania will not be spared of the pain induced by the anti-inflationary measures. In its latest minutes, NBR mentioned that the ability of some firms to remain viable in the context of high costs will be tested. Also the main determinant of GDP growth in Romania is likely to remain private consumption and it is possible to see a slowdown in 2023 under the influence of the gradual increase in interest rates and other factors. However, Central Banks in Eastern and Central Europe started the hike cycle early and now have the option to pause, if the data is pointing in that direction. In August, the Czech National Bank maintained the interest rate unchanged at 7%. But the ECB is not in this position.

Isabel Schnabel, Member of the Executive Board of the ECB mentioned in her speech that the Central Banks should act with determination against “the risk of people starting to doubt the long-term stability of our fiat currencies”. The longer inflation stays high, the greater the risk that the public will lose confidence in the Central Banks’ ability to preserve the purchasing power, according to Mrs. Schnabel. Therefore the banks should act forcefully.

At 0.5% current interest rate and comparable inflation, the ECB is still far from the 2.5% Fed interest rate. The US yearly inflation for July is at 8.5% and in Europe the inflation is comparable if we look at the average in the Euro Area – 8.9% and European Union – 9.8%. While Germany posted 7.5% and France 6.1%, in the Baltic countries the inflation is around 22%, the Czech Republic and Bulgaria are at 17.3%, Poland is at 15.6%, and Romania at 14.96%. In Europe the high energy prices are pushing inflation up while estimates for growth are going down and many analysts are seeing a recession being imminent. Adding into the equation the Euro depreciating more than 12% against the dollar this year and now trading below parity, several voices from the ECB are asking for at least a 0.5% rate increase in September.

The Jackson Hole Symposium made it clear that in the US and Europe it is time for action to aggressively reduce inflation, even if this means to sacrifice part of the economic growth. Therefore it is very likely to see the interest rate hikes policy continue. Rather sooner than later this will impact the labor market, the wages and consumption.