LONDON, June 25 (Reuters) – The umbrella body of the world’s central bank, the Bank for International Settlements (BIS), called on Sunday for more rate hikes and warned the global economy is now at a critical point as countries struggle to keep inflation in check .
Despite the relentless rise in interest rates over the past 18 months, inflation remains stubbornly high in many top economies, while rising borrowing costs led to the most serious bank collapses since the financial crisis 15 years ago.
“The global economy is at a critical juncture. Serious challenges need to be addressed,” said Agustin Carstens, general manager of BIS, in the organization’s annual report published on Sunday.
“The time for obsessively pursuing short-term growth is over. Monetary policy must now restore price stability. Fiscal policy must consolidate.”
Claudio Borio, the head of BIS’ monetary and economic unit, added that there was a risk that an “inflationary psychology” was now emerging, although larger-than-expected rate hikes in Britain and Norway week showed that central banks were pushing “to get the job done” in terms of tackling the problem.
However, their challenges are unique by post-World War II standards. It is the first time that a sharp rise in inflation has been accompanied by widespread financial vulnerabilities in much of the world.
The longer inflation remains high, the stronger and longer-lasting the policy tightening required, said the BIS report, which warned that the possibility of further trouble in the banking sector was now “material.”
If interest rates reach mid-1990s levels, the total debt burden for top economies, all else being equal, would be the highest in history, Borio said.
“I think central banks will get inflation under control. That’s their job: to restore price stability,” he told Reuters. “The question is what the cost will be.”
BANKING CRIES
The world’s top central bankers and other policymakers will gather in Sintra, Portugal, on Monday for a three-day forum hosted by the European Central Bank.
Switzerland-based BIS held its own annual meeting in recent days, where central bankers discussed the turbulent past months.
In March and April, a number of regional banks in the US went bankrupt, including Silicon Valley Bank, and then the bailout of Credit Suisse in the BIS’s own backyard.
Historically, about 15% of rate hike cycles cause severe stress in the banking system, the BIS report showed, though the frequency rises significantly when interest rates rise, inflation rises or house prices rise sharply.
It could even be as high as 40% if private debt-to-GDP 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 surge in house prices in the pandemic era check all these boxes,” the BIS said.
The report also estimated that the cost of supporting the aging population will increase by about 4% and 5% of GDP over the next 20 years in advanced (AEs) and emerging market economies (EMEs), respectively.
Without government tightening, debt in AEs and EMEs would rise above 200% and 150% of GDP in 2050 and could be even higher if economic growth slows.
Part of the report published last week already laid out a “pioneering” blueprint for an evolved financial system in which central bank digital currencies and tokenized banking assets accelerate and smarten transactions and global commerce.
Carstens, former head of Mexico’s central bank, commented further on the economic picture, saying the focus was now on policymakers to act.
“Unrealistic expectations that have arisen since the Great Financial Crisis and the COVID-19 pandemic about the extent and persistence of monetary and fiscal support need to be corrected,” he said.
The BIS thinks an economic “soft or soft” landing — where interest rates rise without triggering recessions or major banking crashes — is still possible, but acknowledges it’s a tough one.
Analysts at Bank of America have calculated that there have been a staggering 470 rate hikes worldwide in the past 2 years, compared to 1,202 rate cuts since the financial crash.
The US Federal Reserve has raised its rates by 500 basis points from near zero, the European Central Bank has raised its rates for the Eurozone by 400 basis points, and many emerging world economies have done much more. Even the Bank of Japan’s ultra-loose monetary institutions may be approaching a turning point.
The question remains what else will be needed, especially given signs that companies are taking 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 made and the last mile will be more difficult,” said Borio, referring to 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; Edited by Emelia Sithole-Matarise and Catherine Evans