(Bloomberg) — A two-speed global economy skewed by US strength is overshadowing this week’s Group of Seven meeting as officials confront the prospect of less synchronized monetary policies.
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Finance ministers in the lakeside resort of Stresa on Friday are weighing the durability of America’s growth momentum against the perennial sickliness of Europe’s expansion — colored by nearby geopolitical tensions — and pondering the implications for financial markets.
G-7 central bankers present know too well that the contrast is matched by differing prospects for consumer prices as a once-in-a-generation inflation shock fades asymmetrically.
Given that backdrop, the euro zone is set to unleash what may turn out to be the club’s first interest-rate cut of the year in less than two weeks’ time, a prospect that has shored up the dollar as the Federal Reserve sticks with a higher-for-longer policy path for now.
“The business cycle is obviously stronger in the US, growth is higher and inflation is a bit more resilient, so our US colleagues will probably wait until they will cut rates,” Bank of France Governor Francois Villeroy de Galhau said on Thursday.
Just before he spoke, a US purchasing managers index showed business activity accelerated in early May at the fastest pace in two years, largely reflecting stronger growth at service providers and accompanied by a pickup in inflation.
Economic Lethargy
Transatlantic growth divergence was clearly preoccupying officials in the approach to the formal meetings that kick off on Friday, with French Finance Minister Bruno Le Maire lamenting to reporters before leaving Paris that Europe suffers from “economic lethargy.”
One presentation to deputy ministers on Thursday underscored how growth in the euro zone is weak with inflation well under control, justifying a steady path of monetary easing in due course, according to a person with knowledge of the meeting.
European officials are still keen to convey to the rest of the G-7 that prospects for the region’s economic growth and inflation are improving, people familiar with their thinking said, declining to be identified because the talks are private.
Meanwhile Bank of Japan Governor Kazuo Ueda — whose own economy just experienced a worse-than-expected start to the year — also insisted to reporters that such an outcome hasn’t changed the “overall picture” for a recovery there.
In contrast to such analysis of weaker economies, Treasury Secretary Janet Yellen emphasized the robust US backdrop while also addressing the current divergence.
“America’s strong economic performance continues to serve as a key engine for resilient global economic performance,” she told reporters. “That said, we know that the recovery has been uneven across our countries and that there are risks to the global outlook.”
Reflecting that, policy divergence could be marked — at least at first — with each monetary jurisdiction plowing its own furrow.
A European Central Bank rate reduction on June 6 is all but certain after President Christine Lagarde said this week that she’s “really confident that we have inflation under control.”
Weakening underlying consumer price growth in Canada has bolstered the case for easing, though a slight increase in the monthly pace might still cast doubt on a June 5 move.
After UK data on Wednesday that showed inflation slowed less than expected, economists at banks from Goldman Sachs Group Inc to Morgan Stanley predicted the Bank of England will shirk from a rate cut in June and wait for August. Meanwhile the Bank of Japan could be gearing up to raise borrowing costs.
For all the divergence for now, OECD chief Mathias Cormann, a participant in the meetings, observed that there may still be limits to that.
“We think that overwhelmingly, monetary policy settings will stay restrictive for some time, which doesn’t mean that there won’t be adjustments down in some jurisdictions,” he told Bloomberg Television.
The most immediate implications of contrasting with the Fed are dollar strength. The Japanese already bring recent experience of that to the talks, having seen the yen weaken to a 34-year low at the end of April before a suspected bout of intervention by the finance ministry.
Based on the communique they issued at their 2023 meeting in Japan, officials could well end up with similar conclusions to then — that there’s little they can do about their different trajectories aside from committing to “clearly communicate policy stances to help limit negative cross-country spillovers.”
Yellen acknowledged the impact on investors, while cautioning that the US isn’t in favor of such action becoming the norm.
“On the strong dollar, this partly reflects interest-rate differentials and market views on the likely paths of interest rates in different economies,” she said. “We believe intervention should be rare, when it occurs it should be communicated in advance, and if it occurs it should largely be in response to volatility in currency markets.”
–With assistance from Oliver Crook, Alessandra Migliaccio, Kamil Kowalcze, William Horobin, Tom Rees, Viktoria Dendrinou and Caroline Connan.
(Updates with OECD chief starting in 17th paragraph)
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