Central banks forced to continue raising interest rates despite slowdown after months of dithering
- Having spent months convinced price pressures were transitory, policymakers have much to answer for as they scramble to combat inflation
- While there is a chance tighter policy can bring down prices sufficiently without causing a recession, it is an increasingly slim one
As recently as last September, the US Federal Reserve was not even sure whether it would raise interest rates this year. While its complacent view of inflation stemmed from a number of factors, one of the most important was the amount of time it took for the Fed and other Western central banks to accept that the 40-year period of subdued prices had come to an end.
From the moment the Fed signalled last December that it would raise rates at a faster pace than anticipated, a series of aggressive increases in advanced economies ensued. A growing number of central banks, including those in Canada and Australia, have implemented large rate rises of half a percentage point or more. Next week, the Fed is set to increase borrowing costs by at least three-quarters of a percentage point.
Bank of America published its latest global fund manager survey on Tuesday. It showed expectations for global growth fell to their lowest level since the poll’s inception in 1994, with most respondents expecting a recession.
More tellingly, households’ expectations of where prices will be in five years fell to 2.8 per cent in July, according to the University of Michigan’s latest consumer sentiment survey. That compares with 3.1 per cent in June.
Moreover, central banks in developing economies, particularly in Latin America and Central Europe, began raising rates aggressively long before their developed-market peers turned more hawkish and are now showing signs of tightening fatigue.
Yet, the end of the Great Moderation also marks the end of the traditional policy response. While central banks could be relied on to halt or even reverse rate increases if necessary when inflation was subdued, they are no longer able to shift to looser policy to prevent a sharper slowdown because of the imperative of bringing inflation back into normal bounds.
Even if prices have peaked, they are not about to come down to acceptable levels any time soon. Core inflation, which strips out volatile food and energy prices, remains high. This is especially true in the US, where rents are rising at their fastest pace in 36 years.
Right now, there is no trade-off between curbing inflation and suppressing growth. To put the inflation genie back in the bottle, policymakers must slam on the brakes. While there is a chance tighter policy can bring down prices sharply enough without causing a contraction in economic activity, it is an increasingly slim one.
As long as prices remain uncomfortably high – a near certainty for the next year or so – beating inflation is the only game in town for central banks.
Nicholas Spiro is a partner at Lauressa Advisory