Axel Weber had a firsthand experience with the 2008 Great Recession as the head of the Bundesbank — Germany’s central bank. He believes that the current crisis is different, but it does have “some similarities” to that dark period in history. Weber, who led the most conservative European central bank until 2011, criticized monetary authorities for their slow reaction to inflation. It was 18 months late, says Weber. The sudden increase in interest rates brought to light the weaknesses of the banking system, particularly in the U.S. “What we have seen are early signs of weakness. And I think they should be taken more seriously,” said Weber in a recent meeting with reporters in Madrid. He believes the biggest impacts of higher interest rates are yet to come: “Normally it takes two or three years.”
Weber, who is currently advising the Flossbach von Storch asset management firm, was previously a frontrunner to succeed Jean-Claude Trichet as head of the European Central Bank (ECB). But Weber withdrew from the race for personal reasons and joined the private sector with Swiss bank UBS. The hawkish German had numerous run-ins with Trichet about public debt buyback programs. The former president of the Bundesbank from 2004 to 2011 believes that the double-digit inflation spike last year was caused by “massive” fiscal and monetary stimuli during the pandemic. The central banks, in his view, didn’t realize this in time and waited at least 18 months to raise interest rates.
The Federal Reserve finally made its move in spring 2022 and the ECB followed in the summer. “We have seen the fastest monetary policy tightening cycle in decades. It’s the biggest rate increase program in the history of the Eurosystem, but also the biggest in the United States since the 1970s,” said Weber. Between 2003 and 2006, Washington had increased the cost of money by 1% to 5.25% due to the dotcom crisis. Then the Great Recession arrived. And although the two crises are not comparable, Weber believes that all the mistakes should not be forgotten or buried — specifically, the weakness of medium-sized banks in the United States. Not surprisingly, the effects of monetary policy are not immediate and turbulence can return. “The biggest impacts of rising interest rates on corporate profit margins, credit conditions, financing, real estate investments, house purchases and mortgages… All of this takes two to three years.”
Central banks are mostly done increasing rates, according to Weber, but he doubts whether the U.S. can reach the 2% inflation target through a “soft landing” as suggested by Fed Chair Jerome Powell. “The analogy of landing an airplane is not appropriate,” said Weber, especially if they go on autopilot. He believes economic cooling will most likely lead to a recession. And he warns investors not to be too quick when central banks begin lowering interest rates.
Capital markets expect the price of money will begin to get cheaper next year — somewhere between 2%-2.5% — but not to the ultra-low rates of before. Weber agrees that the bullish cycle of recent years is over but doesn’t rule out another rate increase in December. However, he urges caution when looking ahead. “The central banks are planning to keep rates high for a while to put an end to inflation.” This is why he says it’s not a good idea right now to discuss whether the central banks’ inflation target should be raised from 2% to 3%, a debate currently circulating among U.S. economics experts.
Given the high deficits and debt left by the pandemic and energy crisis, the issue of when to lower interest rates must be addressed at some point. However, Weber says the major debates ahead will not be about monetary policy. He believes that the crux lies in the pending structural reforms in the labor market, pensions, and cohesion of the social fabric. Lastly, the Eurosystem’s eastern expansion to integrate more countries, like Ukraine, will be a major issue. “The major debates in Europe won’t be happening in the central banks,” said Weber.
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