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Financial Concerns Outweighed by Inflation as Central Banks Continue to Tighten Policy

IMF officials revised their projection for global growth in their most recent World Economic Outlook

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UNITED STATES: As central banks continue to tighten policy, inflation concerns outweigh financial worries. Global monetary officials are focusing on inflation and interest rates despite warnings about the economic risks posed by recent stress in the banking sector. The International Monetary Fund, the bond market, and policymakers warn to proceed cautiously.

IMF officials revised their projection for global growth in their most recent World Economic Outlook. Nevertheless, they issued a warning about “plausible” outcomes from the recent bankruptcies of Silicon Valley Bank and Signature Bank, as well as the compelled merger of Credit Suisse

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This could further reduce growth, while more serious banking issues and tighter credit could cause the global economy to stagnate. Three of the world’s top four central banks are expected to hike interest rates at their upcoming meeting, paving the way for reductions in borrowing costs.

In contrast, despite the most recent financial turmoil, monetary officials appear ready to take additional action to battle excessive inflation, which they still see as the greater risk.

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The Bank of England’s chief economist, Huw Pill, warned that inflation risks remain “skewed significantly to the upside” and that domestically generated inflation remains a barrier to achieving the 2% target. Headline inflation is expected to decline from 10%, the highest rate in the industrialised world.

Japan continues to be an anomaly, where long-stagnant inflation and wage growth are beginning to show signs of change. In his first press conference as governor of the Bank of Japan, Kazuo Ueda emphasised the importance of maintaining an ultra-loose monetary policy to support the long-term achievement of the 2% inflation objective.

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Nothing is yet “broken”

International economic authorities are taking solace in the fact that the COVID-19 pandemic has subsided, and business has returned to normal. Even in the eurozone, where output had appeared to be on the point of declining, there has been an ongoing, if moderate, expansion. This suggests that the dangers associated with the pandemic are declining.

The unemployment rate in the US is close to its lowest level since the late 1960s, indicating that an aggressive year of central bank rate increases hasn’t “broken” any of the economies yet. The present cycle of tightening is likely coming to an end as policymakers aim for a level they believe is sufficiently restrictive to bring inflation into line. 

The exact value of that terminal rate is still unknown, and the cessation of coordinated tightening by the Fed, BoE, and European Central Bank does not signal the end of strict monetary policy. It won’t be easy to revert to the low inflation tendencies of the pre-pandemic era in a normalising global economy.

The policy has been successful in reducing inflation but has been limited to slowing price increases for goods while price pressures for services have remained high.

Enforced inflation

The ECB’s focus has shifted from oil-driven headline inflation to underlying inflation due to concerns that rapid price increase runs the risk of becoming stuck beyond the goal. Wages, services, and food prices are driving price growth to the extent that it is driving price growth.

The ECB’s chief economist, Philip Lane, has suggested multiple rate increases to ensure inflation falls to 2%. Core inflation increased to a record-high 5.7% last month, and overall inflation is 4 percentage points lower than in October.

The “trimmed mean” inflation rate, which excludes items with the greatest and smallest price changes, is a US indicator that Fed policymakers frequently mention. It has shown no progress, falling from 4.75% in August to 4.59% in February.

This is terrible news for the Fed and could raise interest rates. The benchmark overnight interest rate will likely go up by another quarter of a percentage point next month, and the Fed will probably indicate whether more increases are necessary.

Jan Groen and Oscar Munoz, macro strategists at TD Securities, have concluded that some of the inflation from the pandemic era has been “entrenched”, and the US PCE rate is likely to remain around 3%. If this persists, the Fed will likely have to choose between its inflation target or aggressive easing to counteract a potential increase in the unemployment rate.

IMF chief economist Pierre-Olivier Gourinchas believes the focus is on the right things to ensure financial stability and control inflation, as failing to do so would create a problem of its own.

Also Read: Ahead of Trump’s Surrender in New York, Police Brace for Protests with Barricades

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