These are challenging times for central banks.

Some are challenged by credibility issues which aren’t really issues at all, but communication sideshows, quietly ignored at decision time as committees credibly rule their roosts. But how to credibly communicate this?

Other central banks are challenged by awful inflation shocks, oil and food driven. If over 50 percent of your CPI basket is food and oil, one faces Armageddon.

But the real drama, like in any Hobart Challenge, is between the leading behemoths.

Long ago the ECB took the inside lead, informed by its Bundesbank predecessor. Focus on inflation. Nail it. All else follows.

The Fed is a different animal altogether. It wants to balance growth promotion with inflation fighting objectives, preferring to ignore the world, exclusively focusing on domestic issues.

The ECB acquired the inside track early, never raising its interest rates as much as the Fed, leading with generous liquidity provisioning and then turning stingy with rate easing. The ECB was the inflation-fighting machine par excellence.

In contrast, the Fed cut interest rates to the bone, taking the dollar with it.

Fast forward, and US growth prospects have stabilized, if at low levels, and US inflation is gradually rising under the influence of global commodity shocks, oil and food.

But speculative investment behaviour is centrally led by interest rate and currency behaviour.

Though the Fed ignored commodity inflation for a long time, its lower interest rates and weaker dollar translated into higher commodity prices and imported inflation.

The ECB preferred early to err in containing inflation, by not cutting interest rates too far and accepting a firming euro.

This reached a point recently where rising commodity prices sufficiently activated European inflation concerns for the ECB to credibly threaten higher interest rates.

This had the effect of opening the perceived interest rate gap with the US, weakened the dollar and pushed oil prices higher, in turn pushing US inflation prospects higher.

A few bridges too far

This cannot have suited the Fed in the least at this sensitive juncture, and no doubt this will have been communicated to the ECB. It at least created the impression of having overplayed its hand, as markets seemed to believe multiple ECB rate increases were looming, besides embarrassing its colleague. That was a few bridges too far.

And so two things happened in recent days.

US domestic lethargy, and lingering banking adjustment, hardly warrant US rate increases, but the Fed felt compelled to foreswear the dollar weakness leg. And so the Fed sounded hawkish in response to ECB hawkish noises, thereby neutralizing the ECB influence over the weakening dollar and firming commodity prices.

Whether the Fed can deliver on these hawkish promises early enough with rate increases, like in 3Q2008, remains to be seen, except perhaps for a token early start to rate tightening. The real thing will have to await 2009, and even then we will have to wait and see.

Meanwhile the ECB realized its superior position, and the danger of overplaying its hand, now proceeding to furiously backpedal. What’s coming is apparently ONE token ECB rate tightening of 0.25 to 4.25 percent. Thereafter, who knows?

Meanwhile the Fed can only disappoint by not following through strong enough on its vigorous jawboning. That potentially suggests new bouts of disappointment and dollar weakness ahead.

Certainly the ECB has been fully captured by the recent commodity inflation surge, and now the ECB has captured the Fed in its surge.

Kill the commodity inflation surge

But will they between them kill the commodity inflation surge early on?

Perhaps emerging market policy action will be required to complete the global consortium against inflation (the real committee to save the world?) in order to be effective in killing off the oil surge?

Yet this may not be quick in coming, as China and others have domestic political tradeoffs with their poor, unthinkable in industralised countries. And external surpluses makes China especially pretty insular.

Bottom line? The commodity surge isn’t over yet. The ECB means business, but only in limited terms. And the Fed finds itself in the wrong policy quadrant.

The Fed would love to raise US rates, like the ECB, to bolster the Dollar and contain inflation, undoing the commodity surge.

But domestic weakness could severely curtail its actions, limiting intervention to the verbal kind.

Interesting months lie ahead. The full playout may have to await 2009. And that’s in oil. Food is an altogether other kettle of fish.

South Africans may face yet higher commodity import prices and a higher and delayed CPIX inflation peak in 12-15 percent territory. As to how the SARB thinks it will tackle this, all will be revealed at the August, October and December MPC meetings. And then there would always still be 2009 to consider.

Peaking territory still seems very much to lie ahead for commodity prices, CPIX inflation and interest rates. And the growth trough is yet to fully reveal itself.

Cees Bruggemans is chief economist of First National Bank.


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