The era of global cheap money is coming to a timely end
If the Bundesbank were running the show, European interest rates would be on their way up and Germany’s central bank would be busy mopping up the deep pool of cheap and easy money that has been flooding Europe’s economy for years.
Business is booming, factory orders are surging, economic confidence is on a high and inflation pressures are creeping up. And it is not just in Germany where the outlook is improving. Large parts of Europe’s economy are on the mend and it begs the question, what on earth are the European Central Bank’s monetary priorities for the future?
They are either running scared of deep dangers lurking in Europe’s dark economy, or just going overboard with ultra-easy policy overkill as a fail-safe while key elections take place in Europe this year. More likely it’s that they are feeling overwhelmed by all the conflicting crosswinds, and choosing to keep a low profile for now.
ECB doves may be prioritising electoral calm, Greek debt worries and Italian credit risks, but ECB hawks like the Bundesbank will be much more concerned about over-cooking inflation risks and jeopardising Germany’s savings and pensions industry with negative interest rates and ultra low bond yields.
It is not just Europe that is begging for a tougher monetary regime. With US labour markets hitting a 44-year peak, inflation pressures firming and financial markets in a frenzied state about President Donald Trump’s reflation plans, the US Federal Reserve is under increasing pressure to reduce the excess fizz.
Investor euphoria and irrational exuberance have already hardened the odds that the Fed strikes next week with another interest rate rise at the March 14-15 policy meeting. The Fed rightly wants to avoid any blame for whipping up the markets with too much cheap and easy money.
If President Trump is going to stump up stronger fiscal stimulus with major tax cuts and a budget-busting spending binge in the next few years, then the Fed needs to ease off the monetary thrusters as soon as possible or else it really will end in tears for the US economy.
Too much simultaneous stimulus from Trump and the Fed will only end up in domestic over-heating and higher US inflation down the line – potentially much harder to budge than the recent deflation disaster.
Of course, a lot is going to depend on whether ‘Trumpflation’ is the real deal, or just a load of huff-and-puff that will be difficult to enact over the coming years. Either way, the Fed is still right to intensify the hollering campaign, vital for cranking up expectations of much higher interest rates in the longer term.
Rising borrowing costs for US consumers, businesses and investors, plus the resulting stronger US dollar, should all help to smooth out the inflationary lumps and bumps as growth moves onto a more sustainable footing. It probably means a further two interest rate increases at least later in the year as the Fed targets returning official rates to a more normalised 3-4 per cent range in the medium term.
Higher rates from the Fed will bring the era of cheap and easy money around the globe to a timely end. Zero interest rates and lashings of quantitative easing stimulus had a time and a place when the world was on its knees after the 2008 crash, but now look increasingly inconsistent while stock markets are steaming to new highs, on a never-ending wheel of fortune.
Ask any central banker and he will tell you that his job is about moderation, supervision and good governance. It is not about acting as prime broker for market speculators, hedge funds, fast-buck traders or big corporate or sovereign borrowers loading up on ultra-cheap central bank money.
The major central banks are desperately keen to get back to basics and get on with the job of supporting sustainable, non-inflationary growth over the long term. Deflation risks are dead and buried, headline inflation is on the rise and global recovery is gradually building better momentum. The policy sea-change to a global tightening bias is long overdue.
Toxic and systemic risks may still remain, but the overriding priority must be to restore better monetary normality. The Fed is clearly at the vanguard and setting a vital lead for others to follow suit fairly soon.
Once French and German elections are out of the way and the ECB’s quantitative easing programme expires in October, the writing is on the wall for tighter money in Europe early next year.
David Brown is chief executive of New View Economics