The West is (trying to be) back
The conclusions of the G7 summit, albeit not immediately actionable, can be read as a “West is back” manifesto. Still, for this “Cornwall consensus” – heavy on active economic policy – to thrive, central banks must refrain from pulling the brakes. We look hard at the latest US inflation figures and still consider the Fed can remain patient, just like the European Central Bank (EBC) was patient last week.
The G7 last week truly turned the page on the populistic “Trump era”. Observers were quick to criticize the lack of ambition in terms of concrete commitments, but even successful G7 meetings merely set the tone and give general policy directions rather than produce immediately implementable action. The flavor from Cornwall was definitely of the “liberal/progressive” variety. Beyond the obvious focus on the pandemic, fighting climate change, free and fair trade and inclusive growth were the common leaders ‘priorities beyond their political diversity. On economic policy, the “Keynesian conversion” looks complete. The West is more unified and can more easily project its values on the international stage through renewed multilateralism. Still, many policy directions agreed last week will need to pass the “G20 test”. From this point of view, China is the “elephant in the room”. The tone on China was “firm” but very vague on any concrete follow-up. While Biden has managed to narrow the gap with Europe on this issue, nuances still abound. Maybe more fundamentally, while the West may be back “ideologically”, the crucial question is whether it will have the financial resources to win the argument at the global level. The G7 countries are exiting from the pandemic with high levels of debt and lots of internal grievances to tend to, while China is emerging with much of its fiscal and monetary capacity intact.
The “Cornwall consensus” can thrive only if central banks are not forced to pull the brakes. Reassuringly, the market is remarkably non-plussed by the further spectacular acceleration in US inflation. What helps may be the fact that it is still straightforward to attribute the spike in consumer prices to contingent, sector-specific causes which are not “generalized overheating” material. For the time being, the Fed can fairly comfortably maintain its patient stance. In the months ahead we will focus on any sign of “contagion” to a wider array of consumption items, but our baseline has not changed: while inflation is unlikely to return to its sub-par pre-pandemic pace (which would be a good thing), we see little reason to shift away from the “transitory shock” narrative.
The European Central Bank (ECB) chose to be patient as well last week, refraining from signalling a deceleration in the pace of purchases, as we expected. We don’t see the forecast upgrade as sending a hawkish policy message. What remains crucial is that the central bank still expects core inflation at the policy-relevant horizon to be significantly lower than the already sub-par pace they were forecasting before the pandemic.