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“When your only tool is a hammer, every problem looks like a nail.” That old adage still holds true as central banks tighten interest-rate pressures. The impact on wealthy households has been minimal, but the impact on those who can least afford it has been disproportionate. There is an urgent need for better analysis of the soaring borrowing costs, more flexibility in meeting inflation targets and patience as monetary tightening takes effect.
A global recession seems inevitable if interest rates continue to rise. We’ve had warnings from the Gilt crisis, the collapse of Credit Suisse Group AG and several US bank failures. Many other interest-rate-sensitive sectors are reeling, including heavily leveraged commercial real estate and utilities. But the real damage is being done in other areas of the economy, such as small and medium-sized businesses and landlords.
So the stated aim of the Federal Reserve and its colleagues to “loose” the labor market is wrong. No unemployment targets are set in the mandates of the central banks, since the labor market cannot be micromanaged. When the turning point is reached, it is too late to prevent a rapid downturn.
Business loans tend to have variable interest rates, so businesses feel the pain in real time. June US Purchasing Managers Survey reading of 46 suggests decline; The value of 40.6 in Germany should ring alarm bells. Bank lending and money supply measures are slowing around the world. Measures of input inflation, such as producer prices, are declining rapidly. The economy may not be slowing as quickly as central banks would like to curb inflation, but the direction is clear – and there is a risk of an acceleration.
The European Central Bank’s annual global policy forum last week in Sintra, Portugal, sent a unified message to the attending policymakers: further monetary tightening is ahead and borrowing costs will remain high for longer. But policymakers continue to over-rely on econometric models, rendered useless by defiantly high employment and income levels. Fiscal measures such as higher minimum wages, index-linked pensions and social benefits are undermining efforts to control private-sector inflation through interest rates. The answer lies in fiscal restraint and not in blunt monetary policy tools.
Central bankers are too fixated on the 2% inflation target. Such precision does not make sense in an economic system that has faced a series of pandemic-related lockdowns followed by unrelenting monetary and fiscal stimulus. The inflationary impulses are starting to disappear from the system, so more flexibility is needed. And there’s precedent: The Fed introduced a flexible average inflation target in 2020, but dropped it when the pandemic hit.
The situation in the UK feels particularly acute. The futures market expects the Bank of England interest rate to peak at 6.3%, compared to 5.6% for the Fed and just over 4% for the ECB. But as Mark Dowding, who manages $111 billion as RBC Bluebay Asset Management LLP’s chief investment officer, said on Tuesday, “If you go too hard, you will destroy the property market and create a financial crisis in the UK and stagflation.” “
Central banks have a duty to ensure that the poorest in society do not suffer disproportionately from a completely avoidable recession. Andy Haldane, former chief economist at the BOE, argued in a Financial Times article this week that the UK central bank should tolerate above-target inflation and avoid overdosing on the economy in order to break away from the herd mentality that says “no alternative” see further rate hikes.
The BOE’s stick is stretched against the 30% of homeowners with mortgages, while homeowners with no debt are likely to benefit from higher interest rates. Analysts at Jefferies Financial Group Inc. believe the strain of rising interest rates is manageable for the top 40% of earners, who hold three-quarters of mortgage debt. So even if all mortgages are repriced to 6%, they don’t expect any knock-on effects on overall discretionary spending. The biggest risk to this scenario, however, is a sharp rise in unemployment – the very condition the BOE appears to want to create in order to regain its precious 2% inflation target.
Higher interest rates increase inequality. The Office for National Statistics estimates the UK has a savings cushion of 10% of gross domestic product, totaling £340 billion ($430 billion) after surging during the pandemic. For savers and retirees, a risk-free income approaching 5% after a decade of zero returns is a godsend. Wage increases in the private sector of more than 7% are also mitigating the impact for higher earners.
The central bankers, surprised by the surge in inflation, are deliberately ignoring the fact that the tightening measures implemented so far will take some time to take effect. In their zeal to lower consumer prices, they risk compounding the crime of misjudging the outlook by using the blunt instrument of interest rates to drive the economy into recession. It’s time to rethink.
More from the Bloomberg Opinion:
• The big US Treasury crash is far from over: Bill Dudley
• Bank of England rate hike should not have been a shock: editorial
• BOE Says Cry If You Want Higher Rates: Marcus Ashworth
This column does not necessarily reflect the opinion of the editors or of Bloomberg LP and its owners.
Marcus Ashworth is a columnist at Bloomberg Opinion, covering European markets. Previously, he was chief market strategist for Haitong Securities in London.
For more stories like this, visit Bloomberg.com/opinion
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