Global race to hike interest rates tilts economies towards recession

BofA sees UK and euro area falling into recession in the fourth quarter as surging energy costs take their toll on economies this winter

Central banks are intent on driving the world perilously close to a recession.

Late to see the worst inflation in four decades coming, and then slow to crack down on it, the Federal Reserve and its peers around the globe now make no secret about their determination to win the fight against soaring prices — even at the cost of seeing their economies expand more slowly or even shrink. About 90 central banks have raised interest rates this year, and half of them have hiked by at least 75 basis points in one shot. Many did so more than once, in what Bank of America Corp. chief economist Ethan Harris labels “a competition to see who can hike faster.”

The result is the broadest tightening of monetary policy for 15 years — a decisive departure from the cheap-money era ushered in by the 2008 financial crisis, which many economists and investors had come to view as the new normal. The current quarter will see the biggest rate hikes by major central banks since 1980, according to JPMorgan Chase, and it won’t stop there. 

This week alone, the Fed is set to lift its key rate by 75 basis points for a third time. The Bank of England is predicted to boost its benchmark by 50 basis points, and hikes are also expected in Indonesia, Norway, the Philippines, Sweden, and Switzerland, among others.

As they slam on the brakes, policymakers are starting to lace their language with gloom in a public acknowledgement that the higher they raise rates to quell inflation, the bigger the risk they harm growth and employment. Fed Chair Jerome Powell said last month that his campaign to rein in prices “will bring some pain to households and businesses.”

‘Credibility is everything’

Central bankers would rather keep their economies chugging along. They may at some point dial back their aggressive policy to try to ensure that. But their overriding focus now is to avoid repeating the mistake of the 1970s, when their predecessors prematurely loosened credit in response to slowing economies without first getting inflation under control.

Last November, ECB President Christine Lagarde said higher rates were unlikely in the euro area in 2022 only to find herself jacking them up 75 basis points this month and considering a repeat. That action leaves policymakers with a lot at stake in winning the inflation battle.

A BofA survey of fund managers this month found that global growth expectations were near all-time lows.

“It takes time to cool off inflation,” says BofA’s Harris. “If you start talking about only focusing on current inflation as your main indicator, you’re going to be late in stopping” the tightening cycle. Harris sees the UK and euro area falling into recession in the fourth quarter as surging energy costs take their toll on economies this winter, and he expects a US downturn next year.
 

The US economy — and especially the jobs market — has so far proven surprisingly resilient. But economists say this simply means the Fed will have to push that much harder to cool off demand.

Borrowing costs in many economies, including the US, are turning from stimulative to restrictive. A surging dollar is hurting indebted emerging markets. A steep cutback in Russian natural gas supplies is raising the risk of stagflation in Europe, as prices soar while recessions loom.

Central banks all over the world are pushing in the same direction, and that heightens the danger, says Maurice Obstfeld, a former chief economist at the International Monetary Fund.

Since 1980 the world economy has posted an average growth rate of 3.4 per cent. Right now, with monetary tightening adding to the drags from Covid-19 and Russia’s war, Obstfeld sees a risk that it could slow to “somewhere around 1 per cent.”

10-year US yields highest since 2011

Benchmark 10-year US treasury yields jumped to their highest level since 2011 on Monday as investors adjusted for the likelihood that the Fed will hike rates higher and for longer than previously expected as inflation remains near multi-decade highs.

10-year yields reached 3.518 per cent, the highest since April 2011, before falling back to 3.479 per cent.

Data last week showed higher-than-expected consumer prices in August, dashing hopes that the 

worst  may be in the past.

It also made it more likely that the Fed will hike rates by another 75 basis points when it concludes its two-day meeting on Wednesday. Traders are now pricing in a 77 per cent chance of a 75 basis points hike and a 23 per cent likelihood of a 100 basis points increase. 
- Reuters