I was wrong on inflation
For much of the past year I have been a critic of the Fed for keeping rates in easy money territory. One major reason was that they were going to let the inflation genie out of the bottle and that was going to be a problem.
Now, I feel like inflation was only ever a problem in energy and food prices. Now that oil is going down again, that’s manageable. There is no wage-price spiral in Germany (where I thought it most likely to occur because of unions), in the UK, in the U.S. or elsewhere.
Basically, I was wrong on inflation. We’ll get up to maybe 6% in the North America, the Eurozone and the UK before it starts dipping again in Q4 or Q1 2009.
Don’t get me wrong, I still think easy money is bad because it increases appetite for investment risk and leads to bubbles. But, I have to give myself a black mark for getting to riled up about inflation.
Nice to see a commentator voluntarily eating some humble pie – most try and sweep errors of judgement under the carpet. Assume you don’t think the BoE should now promptly follow the Fed’s example because of the different magnitude of the inflationary effect of a yet weaker £ within the UK compared to the domestic effects of a weaker $ in the US? Sterling’s general decline seems nicely managed – so far. If oil continues down under $100, maybe the UK can eventually come out of all this a little less severely damaged than it could have been.
The ECB and the BoE are more hawkish than the Fed and so the BoE will not cut until inflation falls back into the target range.
My core belief is that the Fed would cut when and where it could. The BoE and the ECB are harder to gauge because the historical precedents are different.
Germany is scarred over 80 years later by hyperinflation and the ECB is a German-like/German-derivative institution.
The UK had a tough time in the 1970s when it took three years to get out of recession, inflation soared to 25%, and stocks declined 90% in real terms. The US didn’t go through this. So I think the BoE is naturally more hawkish on inflation.
That said, if and when inflation falls, the BoE will cut too. Sure, the exchange rate can do some of the heavy lifting for now but I suspect they will cut if the CPI falls back into the target range.
Sterling at 1.60 would be an immense tailwind for the MPC. No need for a cut then. So, my best guess is: no cut until November. We’ll see what happens to change my mind.