The Dove Ascending

09/09/2011 at 4:17 pm 1 comment

ECB head Jean-Claude Trichet’s press conference yesterday signalled a more dovish stance on prices. His view now is that risks to inflation in the eurozone have abated in light of the renewed uncertainty over growth and are broadly balanced. While noting that monetary policy remains accommodative in the euro area, his remarks clearly indicate a cessation of the policy tightening that began in the spring. Like the Fed, the Bank of England and others, the ECB is now on hold.

This brings M Trichet into line with a powerful consensus that inflation is the least of the world’s problems at present. The argument runs like this. Over most of the developed world, growth is sluggish and unemployment high. With consumer demand and the bargaining power of labour both weak, there is accordingly no domestic inflationary pressure. Such price rises as we have seen are the result of commodity price increases which have forced up input costs. As growth fears have intensified, commodity prices have come off the boil; therefore, the input cost effect will fall away and inflation will subside.

Economic recoveries, however, tend to be bumpy. The slowdown in growth rates observed for certain economies this year could turn out to be no more than a pause for breath. Commodity weakness could turn out to be equally short lived. How far could commodity prices go? As measured by the S&P GSCI spot index they would have to rise another 33% simply to regain their April 2008 peak (and that’s in nominal terms).

There are those who would simply laugh this possibility out of court. With equity markets bumping along the bottom, bonds near record highs and oil off 2% on the day at time of writing it certainly feels like an eccentric concern. But it is a fact that rates of inflation have in many cases already risen to levels with which policymakers would have been uncomfortable in the pre-crisis past.

It is also a fact that price behaviour doesn’t turn on a dime. Estimates of the time it takes for monetary policy to feed through to prices vary, but a lag of 18-24 months is what is generally assumed. Last December, Fed Chairman Bernanke boasted that should the inflationary outlook deteriorate, he could raise interest rates in 15 minutes if he had to. The problem is, prices could continue to gallop into the distance for more than 15 months thereafter.

The doves are certainly in the ascendant for now, and understandably so. But their view has become absolutely predominant and the policy bias completely one-sided. If the present complacency over prices turns out to have been mistaken their retreat could prove dramatic.


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  • […] to this unspeakable terror in an effort to legitimize their more exotic recent policy action. We had a look at the dove argument on inflation three weeks ago and challenged its tenets then. When it comes to outright deflation, however, we can also invoke […]

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