If Central Banks Raise Rates Together, What Does It Achieve?

Last night, expectations of a September Fed rate increase rose to about 70%: oil climbed above $107, and US August PPI again exceeded forecasts.

The ECB Moves First

On September 10, the European Central Bank raised rates by 25 basis points, bringing its deposit rate to 2.50%, effective September 16. The motivation was inflation driven higher by energy prices. Euro-area inflation was 3.3% in August, up from 2.9% in July. Energy prices rose 14.3% year on year, compared with 10.3% in July.

A Major Central Bank Week Approaches

The Fed was due to meet on September 16, with markets pricing roughly a 70% probability of an increase. Its current target range was 3.50%–3.75%, unchanged since December last year.

The Bank of Japan was due to meet on September 17–18. Markets expected a 25-basis-point increase to 1.25%, a high of roughly 31 years.

The Bank of England’s decision was scheduled for September 17. The prevailing expectation was for its rate to remain at 3.75%. But the July vote had already split 6–3, with three members favouring an increase to 4.00%.

The Shared Adversary: Energy Bills

Oil: on September 10, Brent and WTI both rose more than 6%, closing above $107 and $102, respectively.

US: August PPI rose 5.4% year on year, against an expected 5.3%. Energy prices increased 4.2% month on month, and diesel rose 24.1% in a single month. Goods prices rose 1.1% over the month, the largest increase since May, with more than three-quarters of that rise coming from energy. Services prices rose just 0.1%.

Euro area: core inflation was 2.4%, down 0.1 percentage points from July, while services inflation fell from 3.3% to 3.0%. Core inflation was cooling. The ECB nevertheless raised rates to prevent energy inflation from spreading more widely.

Japan: heavy dependence on crude oil imports continued to push input costs higher.

Raising Rates Together Does Not Mean the Risks Disappear

US interest expenditure was expected to reach about $1 trillion this fiscal year, according to the Congressional Budget Office, already exceeding the defence budget. As the world’s $353 trillion of debt matures, it will have to be refinanced at higher rates. Simultaneous rate increases therefore do not offset one another’s risks. They make debt service more expensive across the world.

Rising oil prices are a supply shock. Higher rates can only restrain demand. They can prevent inflation from spreading, but cannot directly bring down oil prices themselves.

The simultaneous rise in long-term bond yields in the US, Japan, the UK and other economies reflects a combination of greater supply, term premia and geopolitical risks. It cannot be attributed solely to rate increases.

What to Watch Next

Two parts of tonight’s CPI release deserve particular attention:

1. Has the energy component caught up with the latest increase in oil prices?

2. Has core inflation risen? A rise in core inflation would mean that higher oil prices had spread across the broader range of prices.