Central Banks Near Panic As Inflation Continues Despite Rate Hikes

• The Fed is expected to raise its rate by at least 75 bp this week
• BIS is urging central banks to front-load rate hikes to tame inflation
• ECB is under pressure on both rates and quantitative tightening

Panic might be too strong a word to describe what’s driving central bank policymakers, but not by much.

Consensus forecasts regarding the U.S. consumer price index (CPI) missed as the index rose 0.1% on the month when economists expected it to fall. Now analysts have changed their prediction of the Federal Reserve rate hike this week from 50 to 75 basis points (bp) to at least 75 basis points as expectations grow that it could be a full percentage point.

That headline CPI increase was so small only because of a sharp drop in energy prices. The much-prized core inflation rate—which strips out those pesky volatile things like food and energy—was actually up 0.6% on the month.

Along with a big hike at this meeting, investors now expect the Fed to continue raising rates until it can demonstrate it has inflation under control.

A 75 bp hike this week would raise the target for Fed Funds to a range of 3.0% to 3.25%, while futures contracts now suggest the policy rate could top 4% by year-end, implying further sizable increases at the two remaining meetings of the Federal Open Market Committee in early November and mid-December.

The Bank for International Settlements (BIS)—known as the central banks’ central bank—weighed in Monday to defend the rate hikes in the U.S. and elsewhere, even if they risk causing a recession.

BIS chief economist Claudio Borio urged central banks to continue raising rates forcefully. “Front-loading tends to reduce the likelihood of a hard landing,” he said as the Basel-based institution released its quarterly economic review.

Philip Lane, the chief economist for the European Central Bank, said last week that further hikes in the ECB policy rate will be necessary after the shock increase of 75 basis points earlier this month. Europe is even more strapped than the U.S. from inflation as spiraling energy costs threaten to cripple economies and distress households.

Lane was one of those doves who played down the threat from inflation for months, so his acknowledgment that further hikes will be needed is an important signal.

The Fed started earlier with rate hikes and has been more aggressive, putting other central banks on the defensive as the hikes led to a surge in the dollar’s value in currency markets. The appreciation of the dollar exacerbates inflation in other countries because so much global trade is conducted in the U.S. currency. When other currencies fall against the dollar it makes their imports more expensive.

Other major currencies—like the euro, the pound sterling, and the Japanese yen—have fallen against the dollar, putting pressure on those central banks to keep pace with the Fed. Even China’s currency plunged through an important threshold when the dollar rose to above 7 yuan last week. The U.S. dollar index measuring its value against other major currencies has risen 14% so far this year.

The possible impact of quantitative tightening is gaining more attention as central banks start to slow their reinvestment of maturing bond proceeds, withdrawing liquidity from the financial system. The Fed has been running off $47.5 billion of maturing proceeds since June and this month ramps up to $95 billion as it chips away at its $9 trillion balance sheet.

The ECB faces a similar challenge as pressure is growing for it to reduce its 8 trillion euro balance sheet. The euro’s central bank is trailing the Fed in this department as well. ECB President Christine Lagarde said at the last policy meeting it would be premature to discuss QT, but pressure has grown to at least start talking about it at the October meeting of the governing council.

The Bank of England is coming under increasing criticism for reacting too slowly to inflation. The Monetary Policy Committee delayed its meeting scheduled for last week because of the mourning period for Queen Elizabeth II, but it is expected to raise the bank rate by at least 50 bp this week, with some analysts looking for a 75 bp rate hike.