A big week for central banks on both sides of the pond
The most important event was the nomination of Jerome Powell to Fed Governor. Trump broke with tradition twice: Firstly, he did not reappoint the incumbent Janet Yellen who had done a stellar job. (Most US presidents have tended to reappoint sitting governors — especially when they had been successful.)
Secondly, Powell is not an economist, which breaks with nearly 40 years of precedent. The latter may be less significant unless the world economy hits another crisis, when the ability to avail of, as well as the willingness to experiment with, macro-prudential tools may become more important. This holds especially true because policy measures are severely limited given the Fed’s bloated balance-sheet and historically low interest rates.
Still, Powell is supremely qualified for the job: He cut his teeth in investment banking at the Wall Street firm of Dillon Reed, after which he was appointed to the Treasury Department by George H W Bush. He then built the industrial practice of the Carlyle Group and was appointed to the Fed’s Board of Governors by President Obama in 2012.
He is a strong appointee for several reasons.
Firstly: The nomination of Powell is seen as a rather dovish move in terms of monetary policy and he is considered a safe pair of hands. Continuity is the right message for the markets. Janet Yellen’s slow road to shrinking the central bank’s balance sheet and raising interest rates has been rewarded with success: The US economy has added on average 200,000 jobs a month since 2011 and the stock market has reached record highs without apparent signs of overheating.
Powell’s background in financing the industrial sector ensures a link to the real economy, which is often missing in central bankers. His calm demeanour, tenure at Wall Street and in private equity mean that he will most likely be an effective communicator to the markets. He has gained regulatory and central banking experience during his stints at the Treasury and the Fed. The fact that Powell is a Republican might help both his confirmation hearings and his ability to communicate with a Republican-dominated Congress.
Most importantly, Powell belongs to an elite group of senior, white and very rich men with a background on Wall Street. The past ten months have proven that President Trump respects two things: wealth and very senior military ranks.
As much as Yellen might have deserved a second term on the basis of merit, it is crucial that the Fed Governor has the ability to speak truth to power and stands a chance to be heard.
The UK is in a tricky situation as uncertainty over Brexit looms large while the appointment of Jerome Powell to head the Fed sends the right message of continuity to the markets.
The Fed and the Bank of England represented a tale of two central banks.
The Fed’s Open Market Committee decided to leave the base rate unchanged (1- 1.25 percent). Whereas job growth is robust, headline inflation is still below the targeted 2 percent. It will be Powell’s task to steer the Fed into raising interest rates and reducing its balance sheet without curtailing growth in the US or inducing a “taper tantrum” like in 2013.
The Bank of England took the opposite decision in increasing the base rate by 25 basis points (bps) to 0.5 percent.
This was a courageous decision: Whereas headline inflation was approaching 3 percent (the target is 2 percent), the announcement was still anticipated with fear. It was unclear what markets would consider too dovish or too hawkish. Bank of England Governor Mark Carney tried to walk a fine line announcing a rise of 25 bps with potentially two more rate hikes over the next two years.
Markets reacted swiftly and sterling fell by 1.3 percent immediately after the announcement before recovering some ground.
The UK’s situation is tricky, because the uncertainty surrounding Brexit looms large over the economy. The current inflation rate was induced by the pound’s tumble in the wake of the Brexit vote. However, whereas this was bad news for inflation it was good news for exporters, who need all the help they can get to adjust to the post-Brexit environment — whatever it may be.
By now, inflation has probably been priced in, barring unforeseen further depreciation of the UK currency or drastic rises in the oil price.
The rate hike might have been low enough not to curtail domestic investment too much.
However, it may affect untold house owners if they did not fix their mortgage rates.
House prices and mortgage amounts are high — especially in the South East of the country. Household incomes are stretched and wages have far from caught up with inflation. To be fair to Governor Carney, during times of huge economic uncertainty, such as Brexit, it will always be treacherous to make the right moves in monetary policy.
• Cornelia Meyer is a business consultant, macroeconomist and energy expert. Twitter: @MeyerResources
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