Fed Watch: U.S., European Central Banks Diverge On Response To Inflation

The RMB latest foreign exchange markethead of the St. Louis Federal Reserve Bank, James Bullard, is a voting member of the Federal Open Market Committee this year and he wants policymakers to raise the Fed’s key interest rate by a full percentage point by July.

There are three FOMC meetings between now and then—March 15-16, May 3-4, and June 14-15. If Bullard’s view prevails, the committee will have to raise the overnight federal funds rate target by a half-percentage point at least once, even if it hikes the rate the standard quarter-percentage point at the other two meetings.

As Bullard told Bloomberg:

"The exact timing of that I don’t think is as critical as the idea that we begin to move on removing accommodation soon."

In another hawkish move, Bullard also wants to start running off the Fed’s massive bond portfolio in the second quarter. “I’d like to get that issue resolved at the committee. Hopefully we can get that implemented during the second quarter,” he said.

Bullard suggested there was a time when the FOMC would have raised the rate by 25 basis points “right now,” that is, on Friday, the day after the consumer price index came in at a super-hot 7.5% increase on the year. The Fed can act between scheduled meetings and indeed did so to lower rates when COVID-19 hit.

This is not shock and awe, said Bullard, who doesn’t believe in upsetting markets with that tactic. Rather, the 2-year Treasury note yield was already at 1.34% early Friday, he noted, so markets have already priced in his “roadmap” for Fed action.

Measured Fed Moves Vs. Wait-And-See From ECB

If the two measures don’t keep inflation from remaining high by mid-year, well, there’s always the second half of 2022, when the Fed could do more, Bullard says cheerfully.

"Here you have got the highest inflation in 40 years and I think we are going to have to be far more nimble and far more reactive to data than we have been in the last decade, pre-pandemic."

San Francisco Fed chief Mary Daly said on Sunday that rate hikes should be “measured” and respond to data. “History tells us with Fed policy, that abrupt and aggressive action can actually have a destabilizing effect on the very growth and price stability we’re trying to achieve,” she said on CBS’s Face the Nation.

Daly, who is not a voting member this year, was not necessarily talking about the March meeting alone, but about the path the Fed should follow over the course of the year. She does favor a move in March, but then recommends waiting to see what happens.

With even a dovish Daly ready to hike rates in March, the Fed presents a sharp contrast to the European Central Bank, where President Christine Lagarde has only recently suggested there could even be a rate increase this year.

The head of the Central Bank of Ireland warned in an interview published Sunday that it would be a mistake to presume the European Central Bank would start raising rates in June.

Gabriel Makhlouf, who is ex officio a member of the ECB’s governing council, told the Financial Times that policymakers will be careful not to kill off Europe’s economic recovery.

"The idea that we could hike interest rates in June looks very unrealistic to me. I certainly think there’s a bit of difference between the calendar we’re working to and the one some market participants may have in mind."

ECB policymakers are not sure that inflation in Europe is durable, though the eurozone registered a 5.1% price increase on the year for January.

Philip Lane, Makhlouf’s predecessor at the Irish central bank and currently chief economist on the ECB executive board, said last week that eurozone inflation will calm down without any significant tightening of monetary policy by the central bank.

Writing on the ECB blog Lane said:

"Since bottlenecks will eventually be resolved, price pressures should abate and inflation return to its trend without a need for a significant adjustment in monetary policy."

For Lane, the supply-chain disruptions driving up prices in Europe are the result of an external shock, and monetary policy tightening would only add a second shock by reducing domestic demand. He cautioned that “second-round” effects from the initial price surge in other sectors and wages require careful monitoring, but these too should fade, he concludes.

Joachim Nagel, the new head of Germany’s central bank, is not so sanguine. Nagel, also a member of the ECB policymaking council, said he would favor tightening policy if inflation remained high, ending bond purchases over the course of year and raising rates by the end of the year.

Isabel Schnabel, the German member on the six-person ECB executive board, was somewhat less hawkish than her countryman, pinning the need to raise rates on evidence that people were starting to expect higher inflation.

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