“Waiting too long to remove accommodation would be unwise,” said US Federal Reserve chair Janet Yellen last week, meaning she would not raise interest rates yet. She said this “with no hint of irony”, says Liam Halligan in The Sunday Telegraph. “No matter that, for years, too-low-for-too-long interest rates have hammered savers worldwide” and $10trn of bonds sport negative yields – a result of billions of dollars printed and injected into economies and markets.
So accommodative, or loose, has monetary policy been that eight years into the recovery the benchmark interest-rate in the US is still below 1%. There have been a mere two quarter-point rises, bringing the key rate to 0.75%. Yet the Fed is now “running out of credible excuses not to raise”, as Halligan says. GDP growth is robust; consumer confidence recently hit a 15-year high; and the unemployment rate has fallen to a post-crisis low of 4.8%. Wage growth has reached a post-crisis high and is set for further increases as the labour market is at or close to full employment.
Most importantly, says Charles Lieberman on Bloomberg.com, inflation has already breached the Fed’s target of 2%. The annual rate of consumer price inflation (CPI) is at a five-year high of 2.5%; core CPI of 2.3% is a near-four-year peak. And all this even before the Trump government can implement any of the fiscal stimulus it is planning; it promises to give the economy a hefty fillip even as its internal momentum is heating up. Former Federal Reserve chairman Alan Greenspan has warned that if the US economy overheats, inflation could rise sharply as workers demand higher pay, and there could be a rerun of the stagflationary 1970s.
Greenspan famously failed to spot the dotcom and credit bubbles, but he may have a point here. Central banks are always reluctant to temper expansions by making money dearer. The Fed has shown over the years that it is especially loath to dent confidence by rattling stockmarkets, while thanks to the global financial crisis, all central banks are far more worried about deflation than inflation. So they will be inclined to keep inflation-adjusted interest rates negative, encouraging borrowing and spending.
So there is a good chance that inflation could take off suddenly, necessitating sharper than expected rate rises as the Fed scurries to make up the lost ground. Given that companies and governments still have huge debts, that could cause widespread jitters and a nasty market slide. The likelihood that central banks will neglect incipient inflation, and then destabilise markets trying to catch up, is a key reason to hold gold.