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In the race to catch up with inflation, the Bank of England lags behind


n greyhound races, the hare always wins. The greyhounds settle for the minor places. Head to Romford and you might catch tonight’s last race, in which Our Boy Walker is scheduled to go head-to-head with, among others, Bubbly Maniac. May the best dog come second.

I won’t say which of our central banks is the equivalent of Our Boy Walker and which is closer in nature to Bubbly Maniac. I have not met these two doubtless fine beasts and I only know their names courtesy of the Coral Romford advance race cards. I do know, however, that central banks are also currently in a battle for second place. The hare, in their case, is inflation.

Wherever you look, inflation appears to be rising above and beyond the rates predicted by central bankers and economists a year or so ago. Many of these prognosticators will, inevitably, cite mitigating factors. How could they have known about Russia’s invasion of Ukraine and its impact on energy and food prices? How could they have incorporated China’s Omicron-linked lockdown into their projections?

Reasonable excuses, you might think, but the inflationary hare was well on its way long before either of these two events took place. Throughout last year, inflation came in persistently higher than forecast. With unemployment tumbling, with vacancies soaring and with supply chains totally undermined, very loose monetary conditions simply boosted post-lockdown demand even as supply was unable fully to respond. Inflation inevitably accelerated.

Central banks now find themselves in a race to catch up with the inflationary hare. The Federal Reserve is accelerating past its rivals, raising interest rates last week by three-quarters of a per cent, the largest increase since 1994.

At the European Central Bank, many are also itching to raise interest rates. German inflation, after all, is at its highest since 1974. Yet what may be right for the German goose may not be ideal for the Italian gander. The ECB worries about so-called “fragmentation risk”, in which higher rates designed to bring inflation under control serve only to increase fears of an eventual eurozone break up thanks to their impact on the borrowing costs of heavily indebted governments such as Italy’s. To be fair, the ECB’s boffins are on the case but, for the time being, the ECB greyhound is severely handicapped, unable to respond as quickly to inflationary threats as its rival Washington.

The Bank of England, meanwhile, is the kind of greyhound that prefers to avoid standard training regimens. Faced with the highest inflation rate in 40 years, you might have thought the Bank would be shoving UK interest rates higher. This particular greyhound, however, prefers to stay in its trap, chasing after the inflationary hare with reluctance. The Bank’s quarter per cent rate increase last week suggests that, it’s proving to be an also-ran.

Economic historians will recognize aspects of this varied monetary response. In the mid-Seventies, British policymakers worried more about the impact on economic growth than on inflation of the late-1973 quadrupling of oil prices. The Germans did the opposite. The Americans found themselves somewhere in the middle. In greyhound terms, Germany’s Bundesbank chased after the inflationary hare with speed, keeping domestic monetary policy very tight. British policymakers, more like Labradors, were focused only on eating their next supper and not thinking too hard about anything else.

Germany’s Deutsche Mark strengthened against the US dollar while sterling went into freefall against both. No currency, however, was able to keep up with the inflationary hare, one reason why, in the 1970s, the gold price went through the roof. Inflation corrodes the value of paper money. Gold became an attractive alternative.

We’re not quite in Seventies territory yet but both gold and the US dollar are looking perky compared with sterling, the euro and — dare I mention it? — freefalling crypto. That’s hardly surprising. Foreign exchange and bullion markets are a bit like a night at the dogs. Pointers want to back winners. They cannot easily bet on the inflationary hare so they opt for the next best thing. At 1.5-1.75 per cent, US policy rates are still absurdly low compared with America’s 8.6 per cent inflation rate but, in a game in which no one is in a position to catch the hare, the Fed is at least more dogged than its sleepy rivals.

Stephen King (@kingeconomist) is HSBC’s Senior Economic Adviser and author of Grave New World (Yale)


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