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A man walks by a job advert in the window of a business in Los Angeles on June 6. The recent US Bureau of Labor report showed the public and private sector added 339,000 jobs in May despite the Federal Reserve’s aggressive interest rate increases in an attempt to lower inflation. Photo: EPA-EFE
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

By raising interest rates, central banks are playing Russian roulette with the global economy

  • The speed at which global interest rates have risen in the past year suggests central banks are ignoring the fact growth is slowing again
  • Despite US Congress reaching a deal on the debt ceiling, the world could still face a major economic shock if the Fed keeps pressing too hard on inflation
David Brown
David Brown
Why you can trust SCMP
Central banks are supposed to be trusted guardians to promote the right conditions for sustainable growth and financial stability, but are they taking needless risks in their haste to drive down inflation? The undue speed at which global interest rates have been ramped up in the past year suggests they are turning a blind eye to global growth hitting the skids again.
The euro zone witnessed this first-hand last week, sinking into recession while the European Central Bank (ECB) has carried on regardless with tighter monetary policy. The US Federal Reserve’s decision this week on whether to raise interest rates again could mean the difference between sink or swim for the US recovery in the next few months. In a worst-case scenario, world recession could be on the cards.
Fortunately, the United States has pulled back from the brink after Congress’s recent deal to avert a US government debt default. However, a major economic shock might still come later this year if the Fed keeps pressing too hard on inflation.

The US central bank seems convinced the economy is still running too hot and keeping inflation too high in the process. It is clearly focused on factors such as the robust pace of headline job creation, which saw a bumper 339,000-job gain in non-farm payrolls in May – the highest in four months and way above market forecasts for a monthly rise of 190,000 jobs.

Even though US consumer price inflation has dropped fairly sharply from a 9.1 per cent peak last June to 4.9 per cent in April, it’s still too high for the Fed’s liking. The slow pace of moderation in core inflation – still elevated at 5.5 per cent in April – is causing policymakers most angst, as it is much too high compared to the Fed’s long term inflation goal of 2 per cent.

It would be a great surprise to see the Fed taking a break from tightening after 10 consecutive interest rate rises while headline and core inflation rates are still running more than double the desired level.

The market is taking a different slant and factoring in a 70 per cent probability that rates will remain unchanged at this week’s policy meeting, according to the CME Group’s FedWatch tool. The cost-of-living crisis is doing the real damage, badly undermining consumer confidence and leaving retail sales growth at a slack 1.6 per cent from a year ago.

Headline payrolls might be booming, but the US unemployment rate rose to 3.7 per cent in May from 3.4 per cent in April, the highest level since last October. The fallout from the vulnerable US technology and banking sectors is already hitting employment conditions, adding to consumer uncertainty about the future.

The Fed is set for last rate hike this year. Will HSBC, Hong Kong banks follow?

If the Fed does raise rates again this week, it will be like playing Russian roulette with recession. The US recovery is far from secure and recession risks are already high; the economy only grew 1.3 per cent in the first quarter of 2023.

The US inflation surge was caused by a supply-side spike in global energy costs, and it’s no good trying to snuff it out with higher interest rates if the consequence is weaker domestic demand and stagflation, and it is a possible precursor to a damaging spell of deflation. The US consumer has already been through enough over the cost-of-living crisis and doesn’t need the Fed to intensify the pain.
Europe’s recession is probably going to force a reversal of interest rate tightening from the ECB fairly soon. Output in the European Union fell by 0.1 per cent in the first quarter of 2023 and in the final three months of 2022. Even though headline consumer price inflation has only fallen to 6.1 per cent in May, from a peak of 10.6 per cent last October, another interest rate increase would be inappropriate at this stage in the cycle. The European economy looks exposed.
The European Central Bank headquarters in Frankfurt, Germany, seen on February 2. The euro zone has slipped into recession, which is probably going to force the ECB into a reversal of interest rate tightening fairly soon. Photo: AFP

The central banks should learn a lesson from the children’s nursery rhyme, “The Grand Old Duke of York”. Marching interest rates up to the top of the hill and marching them down again is not the way to conduct responsible monetary policy.

The last thing central banks should be doing is adding to economic instability and financial volatility with ill-timed policy changes. It’s time to bend with the wind and ease the global economy’s pain.

David Brown is the chief executive of New View Economics

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