Recession: Central banks are walking a tightrope between inflation and recession

Central banks have stepped up their fight against runaway inflation, a necessary remedy that could have the negative side effect of tipping countries into recession, analysts say.

Last week, the US Federal Reserve announced its biggest interest rate hike in nearly 30 years, followed by the Bank of England’s fifth straight hike and Switzerland’s first in 15 years.

“This week was a first. The craziest of my experience,” said Frederick Ducrozet, chief economist at Pictet Wealth Management.

The moves rattled stock markets as investors feared that while the rate hikes were necessary, they could dampen economic growth if monetary policy tightening became too aggressive.

“Recessions are increasingly likely as central banks rush to raise rates dramatically before inflation spirals out of control,” said Craig Erlam, analyst at online trading platform OANDA.

Capital Economics, a research group, said it does not expect a recession in the United States.

“But the Fed is deliberately moderating demand to reduce price pressures. This is a difficult line to follow and there is clearly a risk that it will go too far and the economy tip into recession,” he said. she said in a note.

Emerging countries could be collateral victims of rate hikes. The dollar rises when the US Fed raises rates.

“A strong dollar will complicate (debt repayment) deficit countries, which often borrow in this currency,” Ducrozet said.

– Swiss surprise – Central banks insisted last year that inflation was only “transitional” as prices were pushed up by bottlenecks in supply chains after governments have emerged from blockages.

But energy and food prices soared following Russia’s invasion of Ukraine, pushing inflation higher and prompting economists to downgrade global growth prospects for this year.

This left central banks with no choice but to act more aggressively than expected.

Australia’s central bank raised rates more than expected earlier this month, while Brazil last week raised its benchmark rate for the 11th consecutive time. Other treks are looming in the United States and Europe.

But it was the Swiss National Bank that caused the biggest shock on Thursday when it announced a 0.5 percentage point rate hike, the first since 2007.

The SNB had focused on preventing the Swiss franc from getting too strong until now.

“The SNB actions are remarkable in that they mark a significant shift in policy (away) from a very dovish stance,” said Michael Hewson, chief market analyst at CMC Markets UK.

The European Central Bank has been slower to act than its peers. It is ending its massive bond-buying program and will finally raise rates next month for the first time in a decade.

The euro zone faces another problem: the yields paid by its governments to borrow money have jumped, with indebted countries like Italy being charged a premium over Germany, a safer bet for investors.

The ‘spread’ has revived memories of the eurozone debt crisis, prompting the ECB to hold an emergency meeting on Thursday, after which it said it would design a tool to prevent further market stress. bond.

The Bank of Japan bucked the global trend on Friday by maintaining its decision not to raise its key rate, sending the yen near the lowest level against the dollar since 1998.

But even the Bank of Japan could adjust its policy, said Stephen Innes, managing partner at SPI Asset Management.

“BoJ members are considering public discontent with inflation and the rapid depreciation of the yen,” Innes said.

“While they plan to maintain the current easing policy, they might consider making some changes to support the currency,” he said.

– No immediate solution – Consumers will have to be patient before seeing rate increases have an effect on prices.

ECB chief Christine Lagarde put it bluntly when announcing rate hike plans next month: “We expect the interest rate hikes in July to have an effect immediate impact on inflation? The answer is no.”

Central banks have no control over some of the issues fueling inflation, such as soaring energy and food prices, and supply chain issues.

Capital Economics said energy and food prices accounted for 4.1 percentage points of the 7.9% rise in consumer prices in major advanced economies over the past year.

He expects oil, gas and agricultural commodity prices to start falling later this year, which would bring inflation down sharply, but core inflation rates will remain high.

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