RSS feedsOnly a few months ago, alarm over rising inflation pushed the world’s central banks to adopt a tougher stance. Among the main players, the US Fed, the Bank of England, and the Bank of Japan restricted themselves to strong language. But the traditionally hawkish European Central Bank, after persistently refusing to cut rates since the crisis started in 2007, raised its key rate to 4.25% early in July.
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It now appears that the ECB has been trigger-happy. Following news that
eurozone GDP fell 0.2% in the second quarter, the first decline since the euro’s
launch, it is clear that risks of recession have worsened.
The ECB will probably cut rates twice in the next few months, probably to 3.75%. The threat of recession is even bigger in Japan, where GDP fell 0.6% in the second quarter. Any thought of edging up Japanese rates from their abnormally low level of 0.5% will have to be postponed until next spring at the earliest.
Inflation has accelerated to 5.6% in the US, 4.0% in the eurozone, and 4.4% in the UK. But the markets are now focusing on the need to avert recession. With oil prices down from their recent highs, inflation is set to peak soon and come down next year. Plans for additional tightening are being dropped in Britain.
Bank of England Governor Mervyn King has acknowledged that recession or stagnation are distinct possibilities. The markets now expect two cuts in UK Bank Rate, to 4.75% later this year and to 4.50% early in 2009.
The US economy is still in trouble, with house prices down 20% from their peak and jobs falling for seven months in a row. Recession is still a risk. But recent positive US growth contrasts favourably with acute weakness in Europe and Japan. US exports are booming. The dollar’s rise to a six-month high against the euro signals renewed market confidence in the US.
But US inflation is unacceptably high. Though the Fed has postponed plans for early tightening, we expect two small increases in the Fed funds rate before mid-2009, to 2.50%. But US growth will improve next year. We expect the dollar to strengthen further against the euro.
