The US Federal Reserve is in the hot seat as investors worry about an earlier interest rate hike than the central bank has indicated.
PARIS: Investors are watching inflation closely, fearing that a surge in prices may ruin the expected strong recovery from the pandemic, although analysts believe Europe is much less exposed than the United States.
Fears that US President Biden’s $ 1.9 trillion stimulus package – which passed the House of Representatives on Saturday – could revive the economy too much have pissed off investors in recent weeks.
A rise in 10-year US Treasury bond yields – a key indicator of expectations – shows markets believe prices are likely to rise much more than last year’s 1.4% gain, which could strain the US Federal Reserve to raise interest rates earlier than expected.
Bond yields rose elsewhere as well, with French 10-year government bonds turning positive on Thursday for the first time in months, while the benchmark 10-year German Bund also rose although it remains negative.
European inflation data for January showed a price jump of 0.9% from a reading of minus 0.3% in December, as rising raw material costs trickle down to services and industrial goods.
After slowing significantly in 2020, inflation is expected to rise this year in Europe as the economy recovers following the easing of measures to slow the spread of the Covid-19 pandemic.
But it’s not so much a spike in inflation that worries investors as the fact that the Fed will be raising interest rates faster than it has announced.
Federal Reserve Chairman Jerome Powell on Tuesday pledged that the US central bank will keep benchmark lending rates low until the economy is at full employment and inflation has consistently exceeded its target of 2 , 0%.
But bond yields have continued to rise, indicating that investors fear a rise in interest rates that would make borrowing and investing more expensive and slowing the economy.
However, many analysts are skeptical that Biden’s stimulus package will trigger massive inflation.
“It is not clear that Biden’s stimulus package will create a lot of inflation,” said Xavier Ragot, head of the French Economic Observatory’s think tank.
For the European Union, it is unlikely that its pandemic stimulus program will do so, he believes.
“The amounts of the European stimulus plans present absolutely no inflationary risk”, he declared.
– ‘No risk of overheating’ –
The European Commission’s stimulus package amounts to 750 billion euros ($ 920 billion), with several EU members also having their own national programs.
“We have a European stimulus program … considerably weaker, and a much greater loss of growth, so there is not the same risk of overheating as in the United States,” said Fabien Tripier, an economist at the United States. CEPII, a research center on the world economy based in Paris.
The US economy contracted 3.5% last year while the drop for the euro area was almost double.
There is “no risk of overheating or a sustained rise in inflation” in the euro zone, insisted last week the boss of the Bank of France, François Villeroy de Galhau.
Gossip from the French Economic Observatory also doesn’t think that if the Fed is pushed by the markets to raise rates, the European Central Bank would be forced to follow suit.
“It doesn’t work that way in macroeconomics,” he said, noting that the monetary policies of the Fed and the ECB had diverged considerably at the start of the last decade.
“With flexible financial conditions still needed to support the economy, the ECB is unlikely to react to the next surge in inflation,” said Jack Allen-Reynolds, economist at Capital Economics.
François Villeroy de Galhau, who as head of the Banque de France also sits on the ECB’s Governing Council, said the central bank wanted “to maintain favorable financing conditions”.
For Fabien Tripier, the ECB must send “a strong signal” to the markets against the idea that “just because inflation reaches 1.5% or 2.2%, speculation on a rate hike should begin”.
The ECB issued a reassuring message on Friday as board member Isabel Schnabel said she could broaden her support for the economy in the event of a sharp rise in interest rates.