As time passes and interest rates show no signs of decreasing, the impatience of the business environment and the population begins to grow. Both of them see their budgets affected by the increase in the cost of credit, which erodes the amounts available for investment or consumption. These frustrations make politicians become the mouthpiece of expectations and, where unfortunately it is possible, to influence the decisions of central banks. I say “unfortunately” because, in consolidated democracies, central banks are protected from any political influences that can only have bad consequences.
Turkey, with its inflation completely out of control for years, is an extreme example of the consequences produced by a politically-controlled central bank. Another example in the same category was offered to us by a country closer to Romania from a political and economic point of view: Poland. Six weeks before the recent elections, the National Bank of Poland offered a decrease of 0.75 percentage points, to 6%, of the key interest rate despite an inflation of over 10%. The decision was considered unexpected by analysts and investors, questioning not only the independence of the central bank, but also the continuation of the disinflation process.
Such “warm” decisions thrown on still “hot” economies will certainly not help much their cooling. But, “still hot economies” when inflation shows signs of decreasing? Yes, because the current decrease in inflation is largely due to lower energy prices and a positive evolution of food prices at the global level. In other words, the causes are rather found on the supply side, while the role played by demand is considered to be still uncertain.
Under these circumstances, the governors of the main central banks seem to look at the declining inflation with skepticism, considering that the most difficult part of the disinflationary process is still to come. Thus, at the beginning of the month, Jay Powell, the Us Fed’s President, warned not only that the American central bank will not rush to lower interest rates, but also that it is ready to increase them further if the situation requires it. Equally, during the same period, Christine Lagarde, the governor of the ECB, emphasized the fact that it is far too early to consider the fight against inflation won, bringing down to earth those who were waiting for the beginning of a period of lowering interest rates in the euro area. Finally, the gallery of skeptical Western governors is completed by Andrew Bailey, the governor of the Bank of England, who also stated at the beginning of the month that “it is too early to talk about interest rate cuts”, even though inflation in Great Britain is expected to drop sharply in the following months.
In the same note, the governor of the NBR, Mugur Isarescu, also warned at the beginning of the month, referring to the monetary policy interest, that “for now we cannot even discuss a reduction”. As in the case of the first governors, his reign’s fears are related to the fact that, even if it has decreased, inflation is high and “it is not clear that it is going down”. In this sense, he mentioned as an example the inflationary impact that the changes in fees and taxes will have from 2024.
We are obviously witnessing a change of attitude among central bankers towards more caution regarding monetary policy decisions despite a disinflationary process that, 7-10 years ago, would probably have made them react more quickly. The explanation of the paradigm shift is given by the Chief Economist of the Bank of England, Huw Pill, in an interview for the FT in which he states that the unprecedented volatility of global developments (pandemic, war in Europe, then in the Middle East) increases the probability that central banks act reactive rather than proactive to economic developments. This happens because the economic indicators they use, very good at predicting economic cycles, were unable to anticipate the shocks we have seen in recent years. This makes the reactions of the central banks rather delayed, requiring a longer waiting period to assess their effects and for the central banks to be sure that no other unforeseen shocks occur.
In addition, Europe seems to be facing a more tense labour market, in which higher unemployment does not automatically bring a balancing of demand and supply. The main reason is related to the difference between the competencies required by employers and those offered by the existing workforce. This means that in the fight for talent, companies enter into an increasing wage competition, which will prevent a rapid inflation decline.
In Romania as well, as long as the stimulus provided to aggregate demand by consumption but also by EU funded investments will not be matched by an increase in potential GDP, essentially limited by infrastructure, the workforce and the undercapitalization of Romanian companies, inflationary pressures will remain persistent, complicating the BNR’s task.
The cold shower applied by so many governors in unison at the beginning of November suggests that, despite expectations fueled by falling inflation, interest rates will remain high for more than the business environment, the population and the governments anticipate. Said situation will limit the credit fueled development, which should rely mainly on savings, profit reinvestment and Next Gen funded development programs, while retraining and engaging the active population.
Have a nice weekend!
