- Central banks around the world have been aggressively raising interest rates for more than a year in an effort to rein in runaway inflation.
- But economists have warned in recent days that price pressures are likely to remain higher for longer.
- Nearly 80% of chief economists polled by the WEF said central banks face “a trade-off between managing inflation and maintaining financial sector stability.”
Federal Reserve Board Chairman Jerome Powell holds a press conference after the Fed raised interest rates by a quarter of a percentage point following a two-day meeting of the Federal Open Market Committee (FOMC) on interest rate policy in Washington, March 22, 2023.
Leah Millis | Reuters
Following the bailout of First Republic Bank by JPMorgan Chase over the weekend, leading economists predict that a prolonged period of higher interest rates will expose further fragilities in the banking sector, potentially undermining central banks’ ability to contain inflation.
The US Federal Reserve will announce its latest monetary policy decision on Wednesday, closely followed by the European Central Bank on Thursday.
Central banks around the world have been aggressively raising interest rates for more than a year in a bid to rein in inflation, but economists have warned in recent days that price pressures are likely to remain higher for longer. .
The WEF Chief Economists Outlook report released on Monday highlighted that inflation remains a major concern. Nearly 80% of chief economists surveyed said central banks face “a trade-off between managing inflation and maintaining financial sector stability”, while a similar proportion expects that central banks will struggle to meet their inflation targets.
“Most chief economists expect central banks to have to play a very delicate dance between wanting to bring inflation down further and the financial stability issues that have also arisen over the past few months,” Zahidi said. at CNBC on Monday.
As a result, she explained, this trade-off will become more difficult to manage, with around three-quarters of economists surveyed expecting inflation to remain high or that central banks will be unable to act quickly enough to bring it back to the target.
First Republic Bank became the weekend’s latest casualty, the third among midsize US banks after the sudden collapse of Silicon Valley Bank and Signature Bank in early March. This time it was JPMorgan Chase who rode to the rescue, with the Wall Street giant winning a weekend auction for the embattled regional lender after it was seized by the California Department of Financial Protection and innovation.
CEO Jamie Dimon said the resolution marked an end to recent market turmoil as JPMorgan Chase acquired nearly all of First Republic’s filings and the majority of its assets.
Still, several leading economists told a panel at the World Economic Forum’s Growth Summit in Geneva on Tuesday that rising inflation and greater financial instability are here to stay.
“People haven’t pivoted to this new era, that we have an era that will be structurally more inflationary, a post-globalization world where we won’t have the same scale of trade, there will be more barriers markets, an older demographic, which means that saving retirees don’t save the same way,” said Karen Harris, managing director of macroeconomic trends at Bain & Company.
“And we have a declining workforce, which requires investments in automation in many markets, so less capital generation, less free movement of capital and goods, more capital demands. That means inflation, inflation impulse will be higher.”
Harris added that this does not mean that real inflation rates will be higher, but that it will require real rates (which are adjusted for inflation) to be higher for longer, which she says , creates “a lot of risk” as “the calibration for a low rate era is so entrenched that getting used to higher rates, this couple, will create failures that we have not yet seen or anticipated .”
She added that it ‘defies logic’ that as the industry attempts to rapidly pivot to a higher interest rate environment, there will be no other casualties beyond SVB, Signature , Credit Suisse and First Republic.
Jorge Sicilia, chief economist at BBVA Group, said after the sharp rise in rates over the past 15 or so months, central banks will likely want to “wait and see” how this change in monetary policy will affect the economy. . However, he said a bigger concern was potential “pockets of instability” that the market is currently unaware of.
“In a world where leverage has been very high because you’ve had very low interest rates for a long time, where liquidity won’t be as plentiful as before, you won’t know where the next problem to be,” Sicilia told the panel.
He also drew attention to the reference in the latest International Monetary Fund Financial Stability Report to the “interdependence” of leverage, liquidity and these pockets of instability.
“If the interconnectedness of pockets of instability does not go to the banking system which generally provides loans, this should not generate a significant problem and, therefore, central banks can continue to focus on inflation,” said said Sicily.
“It doesn’t mean we’re not going to have instability, but it does mean it’s going to get worse if inflation doesn’t come down to levels close to 2 or 3%, and the central banks are still there.”