Fed Chairman Announces “Pain”: When Will Inflation Be Under Control?

Fed chief announces “pain”.
When will inflation be under control?

By Jan Ganger

The Eurozone suffers from high inflation. ECB head Christine Lagarde gives little hope that this will change anytime soon. The European Central Bank is likely to raise interest rates in July.

The days of low interest rates and low inflation are drawing to a close and are unlikely to return in the long term. Two people agree on this, whose assessment of this issue is not entirely insignificant: Christine Lagarde, head of the European Central Bank, and Jerome Powell, head of the US Federal Reserve.

The crown pandemic and Russian war of aggression in Ukraine changed the world forever, they said at the ECB’s monetary policy symposium in Sintra, Portugal. “I don’t think we’re going to go back to a low-inflation environment,” Lagarde said.

It sounded different for a long time. For obvious reasons, the ECB had assumed that inflation would return to a steep decline on its own in the medium term. Because during the pandemic, crown lockouts disrupted international supply chains, leading to supply bottlenecks and therefore higher prices. Supply chains would straighten up again, that was the assumption. Furthermore, at the end of the heating season, energy prices would fall again.

But nothing came of it. The zero-Covid policy of the Chinese leadership with rigid blockades continues to disrupt supply chains. Also contributing to this are the strikes, which temporarily paralyze the movement of containers and merchant ships in the large ports of the North Sea. Furthermore, the attack on Ukraine made oil and gas much more expensive.

The ECB will raise interest rates

Against this backdrop, inflation has literally skyrocketed. In the United States, it reached 8.6% in May, the highest level in more than 40 years. In the euro area, prices increased by 8.1%. At the moment it appears that momentum is losing momentum. But it will likely be some time before inflation turns green around 2%.

And it will also require further rate hikes. The ECB now feels compelled to raise interest rates after a long hesitation. It is considered a foregone conclusion that it will leave the zero line in July. In September – this is the current plan – a second rate hike will follow. The Fed is already beyond it: in the United States, interest rates are between 1.5 and 1.75 percent.

How much the ECB’s assessment has changed is shown, for example, by Lagarde’s warning to overestimate the unexpected drop in inflation in Germany in June. Meanwhile, Fed Chairman Powell has assured that he will raise interest rates as often and quickly as necessary to keep inflation in check. To achieve this, it is also willing to trigger a recession. “This process is likely to cause some pain. But the most intense pain would come if (…) we allowed high inflation to take hold,” Powell said.

However, the environment in which central banks operate has changed over the long term. For example, the pandemic and the Russian attack showed how vulnerable supply chains are. Faced with export bans, lockdowns and sanctions, many companies are considering shortening their just-in-time supply chains, making them safer and increasing inventory, even if it makes production more expensive.

“Think differently”

Lagarde and Powell took it one step further and warned that the globalized world could divide into competing trading blocs. The consequences: disrupted supply chains, higher costs, lower productivity. Companies should include another factor in their calculations going forward, Lagarde said. When choosing suppliers and the location of a factory, it also matters where it is – with “friends or naysayers”.

“Now we have to face new circumstances and think about monetary policy in a different way,” said Powell. In the future, it will be even more difficult to assess how inflation will develop. “Now we understand better how little we know about inflation.”

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