Rabo: “Nobody Ever Got Fired For Hiking Rates When Inflation Is At 7%”
By Bas van Geffen, senior macro strategist at Rabobank
On behalf of the entire RaboResearch team, happy New Year!
As Europeans return from their unseasonably warm Christmas and New Year’s celebrations, energy prices have eased further. Continuing its decline through the holiday season, the benchmark 1-month TTF gas contract is back at pre-war levels. We are now roughly halfway the heating season and European gas supplies still look sufficient, in part thanks to households’ energy savings.
That said, industrial gas rationing also remains an important element of the lower energy use, and this may have to continue through 2023 as Europe starts this year without Russian supplies. Sadly, a lasting ceasefire between Kyiv and Moscow still seems a distant prospect, let alone the restart of European gas imports from Russia. So despite the positive price signals, the energy crisis will continue to haunt the new year. Limited energy availability will also hamper Eurozone activity in the new year, and –in the worst case– could permanently force certain industrial sectors and processes off the continent.
But Europe isn’t the only country facing a downturn. In fact, recessions seem to be a safe bet. The IMF’s Georgieva opened the year with the uplifting message that one third of the world economy will face recession this year, although, she argues, the US may escape this fate owing to its strong labour market. Conversely, as our US strategist has been repeating at nauseam, we are still waiting for an NBER-approved recession in the country as the Fed keeps pressing the brakes on inflation.
Which brings us to the next key theme for 2023 – the risk of inflation persistence but also the risk of policy overshoots.
As President Lagarde welcomed Croatia as the twentieth member of the euro area, she warned that the ECB may have to follow the Fed on a similar path: “we know wages are increasing, probably at a faster pace than expected, but we must be wary that they do not start fuelling inflation.” This echoes the message of the December meeting and suggests that the ECB may have to hike rates higher than expected as long as the downturn remains too shallow to ease pressures in the labour market.
Labour shortages were a key theme last year, with more than 25% of European businesses and as much as 40% of German industry citing a shortage of staff as limiting their output in a December survey by the European Commission. With the difficulties of finding new personnel in the post-Covid reopening fresh in their memories, employers may be reluctant to lay off staff through a shallow recession. The PMI report released yesterday suggests as much: despite further declines in new orders, hiring activity continued – albeit at a slower pace. Such labour hoarding could fuel more wage pressures.
What’s more, structural shifts could potentially add to this labour scarcity. For, as much as some industries may be forced out of Europe, the recent experience with supply chain shocks also continues to drive companies to revisit their current infrastructures. It remains to be seen whether this leads to reshoring, or simply to re-offshoring to other parts of the globe. The latter certainly cannot be ruled out, particularly as tight labour markets and high wages may deter companies from producing in the West. Nonetheless, geopolitical risks and protectionism –including recent moves by the US to limit China’s access to semiconductor technology– could lead some production to be brought back home.
Yet, as central banks remain focused on the upside risks of inflation persistence, that also increases the risks of policy errors. It’s hard to argue with the reasoning of many central bankers that they now stand to lose more if entrenched inflation leads to a loss of credibility than they might lose if they err too much on the inflation-fighting side. To repeat one of my colleague’s quips last year, “nobody ever got fired for hiking rates when inflation is at 7%.” That thinking, however, does increase the risks of an accident. After all, it is hard –if not impossible– to determine when the central bank has done enough to avoid the risk that inflation expectations become de-anchored.
One case in point here is the gradual improvement in the availability of raw materials, and therefore, the easing of input prices. As S&P Global summarised in their Eurozone manufacturing PMI report yesterday, “the rate of input cost inflation was still sharp, but the weakest since November. Output charges were subsequently raised to a weaker extent […]”
As the first week of the year kicks off in earnest today, German inflation figures for December are in focus. These numbers may be somewhat hard to gauge, with headline inflation being affected by one-off energy subsidies. For the ECB, the development of the core HICP will therefore be a more important aspect of today’s release – and this core figure will probably show more persistence. Inflation data for the other major Eurozone countries will follow tomorrow (France) and Thursday (Italy).
The US calendar kicks off tomorrow with the ISM for December as well as the minutes of the December FOMC meeting. The non-farm payrolls will be released this Friday, as a next indicator of just how tight the US labour market remained through the end of 2022.