April 22, 2024
World Economy

Central banks cannot fight recession and a credit bubble at the same time

New home construction fell 14.8pc, doubtless exaggerated by bad weather but unlikely to roar back soon given the jump in the average 30-year mortgage rate to a new cycle peak of 7.16pc. None of this means that the US is necessarily clattering into recession but the post-Covid boom is assuredly over.

Markets have pocketed a perfect soft-landing before it is actually achieved. Banquo’s ghost at this feast is extremely tight money from central banks fixated on lagging indicators of wages and inflation, and trying to repair their reputations after letting inflation take off. They are therefore likely to make a policy mistake.

This is not to say the job of central bankers is easy. What are they to do in the face of rampant speculation from AI stocks to Bitcoin and Ethereum? Monetary tightening is like pulling a brick across a rough table with elastic; you tug and tug, and nothing happens; you tug again, it leaps into your face.

The Federal Reserve, the European Central Bank, and the Bank of England are all talking as if the world economy touched bottom several months ago. They are keeping interest rates very high as an insurance policy against a resurgence of inflation, just in case this really is the 1970s again.

But even standing still has consequences. Real rates are rising passively – and fast – as inflation drops.

Paul Donovan from UBS says real rates in Germany have risen by 160 basis points since the last policy change. This an odd prescription for a country facing the worst property slump in 60 years and also trying to contain liquidity woes at Deutsche Pfandbriefbank before it sets off a systemic German banking crisis.

The ECB’s policies seem so far out of kilter with the needs of a depressed economy that it may end up pushing Europe back into incipient deflation. All three central banks may be underestimating the delayed effects of monetary tightening – past and current – and risk pushing the world economy into a stubbornly long downturn.

As for the credit bubble, it could end two ways: if the doves are right, a weak economy will set off a wave of corporate defaults; if the hawks are right, a strong economy will lead to monetary torture and also a wave of defaults. Pick your poison.

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