Central banks are looking for reasons not to hike interest rates. It is a gamble that may not pay off.

Inflation is on the rise. But interest rates are slow to follow. One would think, given the battering that Alan Greenspan’s reputation has received from those who claim he let the US housing bubble inflate by keeping rates too low for too long, that central banks would be much quicker to respond to inflation this time around.

Instead, from the Bank of England to Bank Indonesia, monetary authorities appear to be hesitating. Oil prices are fuelling inflation – but the hike that followed political instability in the Middle East should be temporary. At least, that is the hope, yet the political risk premium on oil shows no signs of abating in a hurry. And so much rests on what happens in the country that has become the world’s largest exporter and second largest economy: China.

China's growth

The People’s Bank of China (PBoC) has moved to a more decisive tightening cycle, but this could still be a lose-lose situation for global inflation. For one thing, the rise in prices of oil and food look structural: the growing middle class in China (and many other emerging markets) is driving to the supermarket. But more importantly, a core part of China’s anti-inflation strategy consists of allowing faster renminbi appreciation.

In that case, Chinese goods are not going to be getting any cheaper for the rest of the world, even if the PBoC manages to keep local prices under control. The country that exported deflation to the rest of the world in the 1990s and 2000s is beginning to change its macroeconomic policy. That may reduce its massive accumulation of foreign exchange reserves, but it also removes an inflation safety valve for the rest of the world.

Meanwhile, many other countries seem reluctant to face up to that possibility. In the UK, the dubious health of the banking sector and rapid fiscal tightening supposedly give the Bank of England only so much room for manoeuvre. And in emerging markets, the return of risk aversion after events in the Middle East has eased some of the pressure from investment inflows – but for how long? Turkey’s central bank has even cut rates to stem inflows to the Turkish lira, relying on hiking reserve requirements as a way to trim credit growth of 50% per annum.

Most central bankers maintain that they have not altered their mandate or their methods. But they are steering the ship through uncharted and rocky waters. North Africa may not be the only region to suffer political fall-out from the rise in global inflation.


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