A recession might be the only way to halt inflationary pressures

Published by
Nonhlanhla P Dube

Monetary policymakers now face an uphill task to rebuild confidence after missing the inflation buildup.
After underestimating the greatest inflation outbreak in decades, central banks are now driving their economies into recession in order to bring prices back under control.

The bleak prognosis fuels fear that policymakers will overreach as they pursue dramatic interest-rate hikes, just as some now admit they overstimulated during the pandemic recovery.
In the face of inflation that has yet to peak, the central banks in many advanced and emerging nations have no choice but to keep increasing. According to Bloomberg Economics, global inflation will rise from 9 % year-on-year in the second quarter to 9.3 % in the third quarter before falling back to a still-uncomfortable 8.5 % of the year.

The rate of tightening makes a soft landing more difficult. Citigroup Inc. economists predict a global recession of 50%, while Bank of America Corp. economists predict a “mild recession this year” in the United States because conditions have worsened faster than projected.

Investor confidence in policymakers’ ability to avoid a recession has plummeted. According to Bank of America’s monthly fund manager survey, global growth and profit predictions are at an all-time low, while recession expectations are at their highest since the pandemic-fueled slowdown in May 2020.

While labor markets remain strong, central bankers must exercise caution, according to Dario Perkins, the global macro strategist at TS Lombard.

“We’re on a fast track to overtightening,” he remarked. “The concern is that, having been embarrassed by inflation, policymakers now want to make amends, but there is a risk that they go too far and cause unnecessary damage to the world economy.”

Hawks are ascendant

Some officials are already concerned about the rate of increase. They include Federal Reserve Bank of Kansas City President Esther George, who warned earlier this month that tightening policy too quickly could backfire.

The European Central Bank increased its key interest rate by 50 basis points, the first in 11 years and the largest since 2000. According to a Bloomberg survey of experts, the risk of a recession has risen to 45 % from 30 % in June.

The Bank of England is considering a 50 basis point increase, and the Federal Reserve is projected to hike rates by 75 basis points on July 27. The Bank of Canada has already surprised the market with a 100 basis point shift.

Among emerging economies, the South African Reserve Bank raised its interest rate by 75 basis points, the largest increase in borrowing costs in over two decades, while the Philippines stunned markets this month with an unannounced 75 basis point hike.

Monetary policymakers now face an uphill task to rebuild confidence after missing the inflation buildup.

In the United Kingdom, BOE Governor Andrew Bailey has faced criticism from politicians in the ruling Conservative Party who accuse the bank of moving too slowly on inflation. After a ninth straight month of inflation exceeding its projection, Sweden’s Riksbank Governor Stefan Ingves said this month that the bank has had a “bad year” as a forecaster.

Following criticism of the Reserve Bank’s recent performance, Australia’s government has announced a review of the institution. In a rare admission of guilt, RBA Governor Philip Lowe admitted on Wednesday that the bank’s excessive stimulus in the aftermath of the pandemic had exacerbated pricing pressures.

“While we avoided some long-term scarring, this approach has contributed to the inflationary pressures we are now seeing,” he said in a speech.

As a result, he, like many of his peers, must sacrifice economic development in order to keep pricing under control.

“Inflation is expected to worsen before it improves,” stated Ravi Menon, managing director of the Monetary Authority of Singapore, at a July 19 press conference. “A slowdown in economic growth is necessary” to restore global stability.

Citigroup’s research of the Fed’s rising cycle between 2015 and 2018 revealed the economy slowed more swiftly than the Fed predicted — “a powerful reminder that the Fed will need to keep light on its feet and prepare for surprises.”

The blame game

At a recent gathering of the world’s largest economies’ finance chiefs and central bankers, officials were eager to blame Russia for the global inflation wave and severely deteriorating GDP prognosis, rather than their own policy and forecasting blunders.

And some economists understand.

The breadth of recent events, including the pandemic, war, and major weather events that occur, according to Selwyn Cornish, an expert on the history of economic policy at the Australian National University, has complicated the task of central banks.

“How do we forecast these with just enough precision?” he asked. “We should be cautious before being overly critical.”

Getting inflation under control will be critical to restoring public trust in monetary policy, according to Sayuri Shirai, a former Bank of Japan board member who is now a Keio University professor. A spiral of salary hike demands or entrenched attitudes for higher prices, she added, would weaken confidence even more.

“If this occurs, central banks will lose credibility,” she predicted. “Thus, even if current interest-rate increases would hinder economic development, they must prioritize inflation.”

Nonhlanhla P Dube

Nonhlanhla P Dube is a senior news reporter at Rateweb. Nonhlanhla is a student of International Relations at the University of South Africa. She reports primarily on personal finance and economics. You can contact her directly by email at nonhlanhla@rateweb.co.za

Published by
Nonhlanhla P Dube