This week, major central banks indicated that they were prepared to accept a global recession in 2023 while also pledging to increase borrowing prices as part of their continuous fight against sky-high inflation.
The heads of the Federal Reserve, the European Central Bank, and the Bank of England each raised rates by half a percentage point after doing so, and they all predicted further hikes next year despite admitting that their respective economies were contracting.
The possibility is growing that the world economy may contract next year, so soon after the pandemic-driven downturn, as a result of much tighter monetary policy being implemented on top of the worst squeeze in four decades.
The response function of policymakers, including Fed Chair Jerome Powell, has changed as a result of the fastest inflation rate since the 1980s. Normally, they would be expected to loosen credit when economies fell apart to lessen harm to individuals and businesses.
However, despite economic contractions, central bankers are acting in the opposite direction due to a price rise that is significantly higher than their 2% target. They also maintain that rates will remain higher for a longer period of time in order to combat inflation, but many investors are betting that this position won’t last as economies falter and unemployment increases.
There is a risk that central bankers will do the opposite error from what they did last year.
They downplayed the risks of rising pricing pressures in nations that were still struggling after the pandemic back then. Due to the unchecked inflation caused by this, this year’s swift turnabout with significant rate increases was necessary.
Officials are now promising to continue their fight against inflation despite the possibility that price pressures are beginning to ease, particularly for commodities as economies slow and supply lines unclog.
They continue to be especially concerned about rising pricing expectations and increased pressures seeping into their economy, just like it did in the 1970s.
A day later, President Christine Lagarde stated that the ECB also had further to go.
The Bank of Japan is one exception, as it is anticipated that it will retain its ultra-loose policy settings the following week.
Authorities underestimating how rapidly inflation can decline when development slows and Covid-19-damaged supply chains unclog is a new concern for the entire world. Their rigid approach poses the risk of escalating an already bad situation and lengthening downturns, which central bankers believe will be brief and shallow.
Officials from the BOE openly believe that the UK is already in a recession, and their counterparts from the ECB believe that the euro area entered one this quarter. The invasion of Ukraine by Russia has caused oil prices to skyrocket, which has severely impacted both economies.
Although the US is less vulnerable to the effects of the conflict, the economy is nonetheless in danger of a slump due to the impact of increasing inflation and interest rates. Powell has refrained from declaring that a recession is imminent, but two of his colleagues have projected that the gross domestic product will drop next year.
While 2023 will certainly see more rate increases from all three central banks, they won’t likely be as consistent as this week.
Lagarde told the markets that they are underestimating the ECB’s commitment while Powell kept the door open to the Fed reducing its boost in interest rates to a quarter-point increase in February. She outlined plans to start selling off a stockpile of roughly €5 trillion ($5.3 trillion) in bonds and hinted that at least two additional half-point steps are on the way.
Meanwhile, BOE rate reductions are becoming more visible. Two officials opposed a boost and said that the policy should soon be relaxed, despite the fact that a majority of the board this week opted to raise by a half point to 3.5%. According to the meeting minutes, they consider that 3% is more than sufficient to bring inflation back to target, before going below target in the longer run.
The labor market is a crucial area of attention for all three central banks. According to the Organization for Economic Cooperation and Development, the third quarter had the lowest rate of unemployment in major industrialized nations since the early 1980s, at 4.4%. As a result, employers are under more pressure to raise prices.
The financial markets must be on their side as well. If they continue to ease, some of the higher borrowing costs will be offset.
Each central bank faces a particular type of inflation. Former New York Fed President William Dudley, who is currently a senior consultant to Bloomberg Economics, said on Bloomberg Television that in the US, it’s all about the labor market.
Pent-up demand after the epidemic and the weakening of the euro contribute to the momentum. In the euro region, disruptions in the energy supply account for a large portion of the inflationary drive.
Businesses and individuals are benefiting from government pricing controls, but predictions for future inflation are growing. Over the next three years, the ECB anticipates wage growth at rates significantly above historical averages.
With Europe’s energy price shock and tight labor markets a la the US, the UK appears to have the worst of both situations. Since mid-2021, wholesale natural gas prices have multiplied seven times, and employment has decreased by 200,000 from pre-pandemic levels. Due to illness, employees have taken early retirement or quit their jobs.
Labor shortages are pushing up wages even if there are still plenty of openings. The current rate of 6.9% growth for regular private-sector compensation is the fastest this century excluding pandemics.
Despite this, he believes the ECB has the most difficult job due to the region’s susceptibility to Russian energy sources and the unpredictable nature of the winter climate.
News Mania Desk
