Author: Martin North

We had a series of important events this week which really underscored for me some of the central questions about inflation, inflation targeting and Central Bank policy.

So today I want to explore this in more detail, as the ECB lifted rates by 75 basis points and the Dow closed higher on Thursday after struggling for direction as Federal Reserve officials including chairman Jerome Powell vowed to continue the fight against inflation.

The broader market was choppy and struggled for direction, swinging between gains losses as Treasury yields climbed on hawkish remarks from Powell vowing to persist with rate hikes.

Over in Europe the European Central Bank hiked interest rates by a historic amount and President Christine Lagarde hinted it could do the same again as part of “several” future moves to escalate officials’ attack against rampant inflation.

So, the common theme from Central Bankers is inflation must be contained. Indeed, Philip Lowe yesterday reemphasised this imperative, despite the impact in the short run, because of the longer-term consequences in a speech he gave.

But the deeper question is whether Central Bankers know what they are doing. And Mervyn King at one time the Governor at the Bank of England, was very critical of the assumptions underlying the attempt to control the current inflation cycle.

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US Markets started September on a weak note, after the Monday holiday, extending a slide that started at the end of August, as hawkish comments from Fed policymakers and data signaling U.S. economic momentum raised fears of aggressive interest rate hikes.

The S&P is down nearly 18% so far this year, while the NASDAQ has shed over 26% as rising interest rates hurt megacap technology and growth stocks. Central Banks are being data dependent – meaning their rapid rate-lifting cycle decisions are determined by the emerging data stream.

Overnight The Institute for Supply Management’s services index unexpectedly improved to 56.9 last month, while S&P Global’s final August gauge of business activity dropped to 43.7. In both surveys, a reading of 50 is the dividing line between expansion and contraction. The last time the ISM measure exceeded the S&P Global gauge by that much was during the depths of the pandemic in April 2020. The most striking divergence in these two prominent gauges of US services activity since April 2020 can probably be traced in large part to what types of companies are surveyed and differences in methodology.

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