Jim Power: Central bankers face dilemma with shift in global trading order
The European Central Bank cannot back away from cutting interest rates further. It may delay cuts, but they must come given the economic backdrop.
The world is confused and few understand what is happening or what will happen. Tariffs are the immediate focus and Trump is sending a message that he wants to dramatically change the global trading order.
This is consistent with his anti-free trade views, which he has espoused for four decades. There should be no surprises, yet most of us are surprised.
Given Trump’s stated aims, his actions on tariffs make no sense whatsoever. Tariffs will damage global growth, drive consumer prices higher, will not bring many jobs back to the US, and will just fuel global geo-political tensions. However, Trump would not be one to let facts get in the way of a good story.
Forecasting agencies and central bankers are really struggling with the threat of tariffs. Last week, the Paris-based Organisation for Economic Co-operation and Development (OECD) revised down global growth forecasts and pushed inflation projections higher.
The Central Bank of Ireland revised down its growth forecasts and pushed inflation projections higher.
The real conundrum is for central bankers, who set interest rate policy.
On Wednesday last, the US Federal Reserve left interest rates unchanged while revising its global growth projections down and its inflation projections up. The monetary authority is concerned about the impact of tariffs on growth and inflation.
Likewise on Thursday, the Bank of England left rates on hold. It pointed out that global trade policy has intensified, and that other geopolitical uncertainties have increased.
The reality is that the British economy is in a bad place, with gross domestic product growth contracting again in January.
On Wednesday, the chancellor will face a significant dilemma as she presents the spring statement — which is just another name for the budget.
The fiscal deficit needs to be reduced, but cutting spending and increasing taxes are not what the economy needs now, though the fiscal situation warrants a combination of both. Lower interest rates will have to be used to counter these forces.
The European Central Bank (ECB) is facing a similar dilemma. It has warned that 25% US tariffs would knock 0.3% off growth in the first year and, if the EU retaliates in kind, the drop would be around 0.5%.
However, tariffs would damage the inflation outlook.
The refrains are all remarkably similar: Tariffs are threatening growth on the downside and inflation on the upside. My sense is that while tariffs will drive measured inflation higher in the near term, the impact on growth from higher prices should be a more important consideration.
The European Central Bank and the Bank of England cannot back away from cutting interest rates significantly further. They may delay cuts, but they must come, given the economic backdrop in the eurozone and Britain.
For Ireland, the risks are palpable. Globalisation and free trade have driven the global economy since the Second World War, with the formation of the General Agreement on Tariffs and Trade in 1947; its replacement by the World Trade Organization; and the formation of what we now call the EU in 1958 — all initiatives to push the freedom of movement of goods and services.
Ireland has been a major beneficiary, but the dramatic shift in the global trading order will have negative consequences for us.
Rather than argue about speaking rights in the Dáil, our sleepy and ineffectual Government should engage in a longer-term strategy for sustained investment in renewable energy, water infrastructure, education, health, and, most importantly, housing. These are the areas we need to invest in as a matter of priority.
- Jim Power has worked as an economist in the private sector for 35 years.
