On the same day in which the May inflation data was released (stable compared to April and increasing by 3.3% in trend terms), the Federal Reserve decided to leave interest rates unchanged (between 5.25% and 5.5%) and now plans to make just one cut by the end of the year. Meanwhile in Europe there has been no shortage of shocks on the government bond market following the result of the elections for the EU Parliament and its consequences in France. We asked Domenico Lombardi, economist, director of the Luiss Policy Observatory and former advisor to the International Monetary Fund, for a comment.
Inflation in the United States still remains above 3%. What consequences could it have for the rest of the world? Is there a risk that it will be “exported”?
The difficulty of stabilizing the last mile of inflation and accelerating its convergence towards the medium-term target is pushing the Fed to maintain intervention rates at historically high levels. The result is, if anything, a strengthening of the dollar compared to other currencies. To mitigate the depreciation of their currency, some central banks – especially in Asia – are intervening in the foreign exchange markets. The intent is not only to limit the inflationary potential resulting from the depreciation against the dollar, but to prevent this from becoming an election campaign theme in the United States, pushing the winner of the next American presidential elections to adopt restrictive trade policies, more than they are become to this day.
The Fed plans to make only one rate cut between now and the end of the year. Will it be in September?
Following the release in recent days of inflation data for the month of May, unchanged compared to the previous month, market expectations regarding a rate cut at the meeting next September have strengthened. Studying the forecasts formulated by the members of the Fmoc of the Fed, the body that decides on rates, it emerges that the majority expects one or two cuts at most by the end of the year. However, I believe that the FMOC wants to see, in addition to last May, encouraging inflation data for the rest of the summer as well. Only in this case will it proceed with the cut in September. It should be considered that the wait for the first cut has taken on the value of signaling a substantial and progressive easing of the monetary policy posture. In other words, in the absence of such expectations, the Fed would have less hesitation in making a technical adjustment by lowering the intervention rates. What President Powell wants to avoid is that such an adjustment triggers expectations of a change in monetary policy posture, which makes the Fed particularly cautious at this stage.
The result of the European elections, especially for the consequences it had in Francecould it lead investors to prefer assets denominated in dollars over those in euros?
The markets have no ideologies and simply favor those who ensure the solvency of their credits. If the governments or political forces that aspire to this role ceased to reassure them with conviction and credibility, at that point the markets would not hesitate to turn against them. In the specific case of France, President Macron’s decision to dissolve Parliament without any apparent strategy other than political gambling and the demonization of the largest French party is creating political chaos that is perplexing the markets as well as the other European chancelleries.
Without prejudice to the principle of independence of the ECB in its decisions, he thinks that what is happening and could happen in France, with what this entails for the yields of government bonds (not only French), could lead the Eurotower to take special measures?
I think it’s still premature. If it ever happened, Macron – who is already in serious difficulty with his electorate by which he was heavily defeated last weekend – would break a record to which no European leader has ever aspired.
In a recent interview, Christine Lagarde explained that the ICC could also be used by a country undergoing excessive deficit proceedings. Do you believe that this instrument would be sufficient to deal with possible turbulence in the spread of countries such as Italy or France?
The effectiveness of the ICC has never been tested simply because the program has not been activated since its introduction in 2022. In any case, the signal that the ECB credibly intends to compress the spread would be fundamental, even without the formal activation of the ICT. Moreover, this happened with the OMT when the then president of the ECB Mario Draghi announced its creation – and its credible activation – in 2012. I believe that President Lagarde wanted to convey some initial signals in this regard. The consequences of the activation of the ICC would, however, be devastating on a political level for the country that benefits from it – in fact it would imply a commissionership of the Government in office.
In light of this overall picture, how do you see Italy’s already difficult situation in terms of public finances and growth?
The picture is inevitably becoming more complicated, but precisely for this reason it is necessary to maintain a hyper-prudential posture in fiscal policy, favoring reforms on the growth side with limited fiscal impact.
(Lorenzo Torrisi)
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