Why some central banks are rushing to raise rates now

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Central bankers around the world are sending out a message: slow and steady will not win the race against inflation.

“If we don’t raise rates now, high inflation may stay with us for longer,” Bank of England Governor Andrew Bailey said after unexpectedly raising interest rates by a quarter. half a percentage point on Thursday.

Although inflation is easing in many countries after more than a year of interest rate hikes, it remains above the 2% level targeted by many central banks.

Raising interest rates is the main tool available to central bankers to bring inflation down. At the same time, research indicates that there is a lag effect of at least 12 months between when a central bank acts and when its actions are felt throughout the economy.

That’s why the Federal Reserve suspended interest rate hikes at its June meeting after 10 consecutive hikes since last March. Still, many Fed officials are warning that interest rates could rise next month because, like Bailey, they don’t want to risk losing their grip on inflation if they don’t act now.

For what NOW seem to be such a critical moment?

Central bankers have a very delicate balancing act. For a while it looked like they could raise rates without significantly hurting their savings. But now time is catching up with us. And with inflation still higher than they would like, the risks of doing too much to bring inflation down are comparable to those of not doing enough.

Christine Lagarde, President of the European Central Bank, recently likened rate hikes to an airplane flying to a destination.

“At first, the plane has to climb steeply and accelerate quickly,” she said in a speech she gave earlier this month. “But as it gets closer to its target altitude, it can reduce the acceleration and maintain its current speed. The plane must climb high enough to reach its destination, but not high enough to overshoot it.

“The plane is still rising – and it will continue until we have enough speed to hover sustainably and land at our destination,” Lagarde said two weeks before the ECB hiked interest rates by a quarter of a pound. percentage point. Consumer prices in the 20 countries that use the euro rose by 6.1% in May, against 7% a month earlier.

Another way to interpret Lagarde’s analogy is that if the plane does not climb high enough to a safe cruising altitude, it could face excessive turbulence that prevents it from reaching its destination by 2% d ‘inflation.

This is exactly what worries central bankers.

One of the reasons central banks have struggled to bring inflation down is because parts of the economy are not responding to rate hikes. For example, in the United States, prices for non-energy services rose 6.6% from a year ago, according to data from the May consumer price index. While last year’s prices were up 5.2% from 2021, I‘has become apparent that the high prices of services are rigid.

It is more difficult for central banks to suppress inflation when it becomes sticky or persistently high. But it is not impossible. It’s just a matter of how much pain they are willing to inflict on an economy through rate hikes to bring inflation to the desired level.

However, taking too long to make that decision has its own consequences, said Michael Bordo, professor of economics and director of the Center for Monetary and Financial History at Rutgers University.

“The longer they wait, the more tightening it will take to bring inflation down,” he told CNN. Indeed, research shows that inflation, if left unaddressed, could become even stickier and more difficult for central banks to control with rate hikes.

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