With unemployment rates starting to fall in the developed world and inflation rates starting to rise, will central banks finally start to raise their historically low key interest rates?
Don’t count on it.
In the U.S., the Fed has the dual mandate of price stability and full employment. But this can be particularly tricky in a stagflationary environment of high unemployment and high inflation, which some argue we might be entering.
As a result, central banks have been hesitant to raise rates in fear of sending the economy back into recession. To help justify this decision, most central bankers have scoffed at actual inflation numbers (much to the chagrin of citizens), brushing aside skyrocketing food and energy prices.
But note how much inflation has started to rise in the EU. Unlike the Fed, the European Central Bank has a stated inflation target (“below but close to 2%”). But it’s doubtful the ECB will actually raise rates with crippling government debt and high unemployment rates.
Russia has been going through this same problem over the last year. In March 2010, unemployment stood at 8.6% while inflation was 7.2%. The Bank of Russia, until last month, actually lowered rates to bring its unemployment rate down. It was somewhat successful, but look at the cost of that decision. Inflation rose 230 basis points in the last year.
Most of the other emerging markets have been tightening over the last 12 months, however, in order to fight inflation. Brazil’s key interest rate is up 300 basis points in the last year, for instance.
Keep in mind that central banks have other monetary policy tools besides changing interest rates, like setting reserve requirement ratios for banks. This sets the minimum reserves banks must hold rather than lend out. This can have a dramatic effect on a nation’s money supply.
This has been a major policy tool for China’s central bank as it attempts to reign in inflation. In fact, it was recently announced that the People’s Bank of China will raise the reserve requirement ratio for banks by 50 basis points to 20%.
To put that in perspective, the reserve requirement ratio in the U.S. is 10% on transaction deposits and 0% on time deposits. The Fed doesn’t utilize this tool very often though.
Also in the charts you can see that Australia seems to be firing on all cylinders. Inflation is relatively tame and unemployment is low. Young Europeans might want to consider a move to the Land Down Under.
Todd Bunton is the Growth & Income Stock Strategist for Zacks.com.
