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According to the BIS, the world economy is at the crucial moment in the fight against inflation
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Sees a significant risk of further problems in the world banking system
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The “obsession” with short-term economic growth must end
By Marc Jones
LONDON, June 25 (Reuters) – The Bank for International Settlements (BIS), the umbrella organization of the world’s central banks, called for further rate hikes on Sunday, warning that the global economy is now at a crucial juncture as countries struggle to curb inflation.
Despite the relentless rise in interest rates over the past 18 months, inflation remains stubbornly high in many top economies, while rising borrowing costs triggered the worst bank failures since the financial crisis 15 years ago.
“The global economy is at a critical juncture. Serious challenges need to be addressed,” said Agustin Carstens, director general of the BIS, in the organization’s annual report released on Sunday.
“The time to obsess over short-term growth is over. Monetary policy must now restore price stability. Fiscal policy must consolidate.”
Claudio Borio, head of monetary and economic affairs at the BIS, added that there is a risk that “inflationary psychology” is now taking hold, although stronger-than-expected rate hikes in the UK and Norway last week showed central banks urging “get”. “get the job done” in terms of solving the problem.
However, their challenges are unique compared to the post-WWII era. It is the first time that a rise in inflation has been matched by widespread financial vulnerabilities in much of the world.
The longer inflation remains elevated, the stronger and longer the necessary monetary tightening will be, the BIS report said, warning that the possibility of further problems in the banking sector is now “material”.
If interest rates returned to mid-1990s levels, all other things being equal, the top economies’ overall debt-servicing burden would be the highest in history, Borio said.
“I think central banks will get inflation under control. That is their job – to restore price stability,” he told Reuters. “The question is what the cost will be.”
BANK CRISES
The Switzerland-based BIS held its annual meeting in recent days, at which leading central bankers discussed the turbulent past few months.
In March and April, several US regional banks failed, including Silicon Valley Bank, and then came the Credit Suisse bailout in the BIS’s own backyard.
Historically, about 15% of rate-hike cycles have triggered severe stress in the banking system, according to the BIS report. However, the frequency increases significantly when interest rates rise, inflation rises, or property prices have risen sharply.
It can even be as high as 40% if the private debt ratio is in the top quartile of the historical distribution at the time of the first rate hike.
“Very high levels of debt, a notable rise in global inflation and the sharp rise in house prices during the pandemic all meet these criteria,” the BIS said.
It has also been estimated that the cost of supporting aging populations will increase by around 4% and 5% of GDP over the next 20 years in advanced (AEs) and emerging market economies (EMEs), respectively.
Unless governments tighten their belts, it would push debt in the Arab and emerging economies to over 200% and 150% of GDP respectively by 2050, and could be even higher if economic growth slows.
Part of the report, released last week, also laid out a “groundbreaking” blueprint for an evolved financial system, where central bank digital currencies and tokenized bank assets make transactions and global commerce faster and smarter.
Carstens, former head of Mexico’s central bank, continued to comment on the economic situation and said the focus now is for policymakers to act.
“Unrealistic expectations that have arisen since the Great Financial Crisis and the COVID-19 pandemic about the scale and durability of monetary and fiscal support need to be corrected,” he said.
The BIS believes a “soft” or “soft” landing of the economy – where interest rates rise without triggering recessions or major bank crashes – is still possible, but acknowledges that it is a difficult situation.
Bank of America analysts have calculated that there have been a whopping 470 rate hikes worldwide in the last two years, compared to 1,202 rate cuts since the financial crash.
The US Federal Reserve has hiked interest rates by 500 basis points from near zero, the European Central Bank has hiked rates by 375 basis points in the Eurozone and many developing countries have done far more.
The question remains what more will be needed, especially given signs that companies are seizing the opportunity to boost profits and workers are now demanding higher wages to prevent further erosion of their living standards.
“The easy gains have now been reaped and the last mile is getting tougher,” Borio said, citing the challenges central bankers now face in bringing inflation back to safe levels. “I wouldn’t be surprised if there were more surprises.”
(Reporting by Marc Jones; Editing by Emelia Sihtole-Matarise)
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