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Central banks
Opinion
Nicholas Spiro
Nicholas Spiro

Macroscope | High inflation or economic turmoil? Central banks face unpalatable policy choices

  • Raising interest rates high enough for inflation to start falling was relatively straightforward for central banks, but bringing it down to target levels will be tricky
  • The lag inherent in monetary policy means it is hard to know whether central banks have done too much

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Customers shop at a retail store in Vernon Hills, Illinois, on June 12. The highly anticipated US recession still has not arrived as consumers keep spending and employers keep hiring despite higher borrowing costs. Photo: AP
Nicholas Spiro
It is crunch time for the world’s leading central banks. For the past year and a half, their overriding objective has been to quell inflation. Having underestimated the severity and duration of the price shock, central banks in advanced economies have raised interest rates aggressively, mainly to re-establish their inflation-fighting credibility.
The dramatic tightening in monetary policy has helped ease price pressures. In the United States and the euro zone, annual headline inflation has fallen to 4 per cent and 6.1 per cent, respectively, down from close to 9 per cent a year ago. The declines are set to continue, with price gains slowing to roughly 3 per cent by December, according to JPMorgan data.

Stock markets have surged this year. The MSCI World Index, a gauge of equities in advanced economies, is up more than 12 per cent. The results of Bank of America’s latest global fund manager survey, published on June 13, showed that only 2 per cent of respondents expect higher inflation a year from now while a net 67 per cent anticipate cuts in interest rates.

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Yet, it is what happens in the intervening period that is starting to unnerve investors. In recent months, hawkish signals from policymakers – including the resumption of rate increases by the Australian and Canadian central banks following a brief pause in their tightening campaigns – have brought the persistence of the inflation threat into sharper focus.

While headline inflation has fallen sharply, core inflation – which strips out volatile food and energy prices – remains sticky. In the US and the euro zone, it has stayed above 5 per cent since the end of last year. In Britain, core inflation has risen to 7.1 per cent, forcing the Bank of England to step up the pace of rate increases to prevent a wage-price spiral, when inflation becomes baked into workers’ wage demands, further driving up prices.

Striking junior doctors from British Medical Association take part in a rally in Parliament Square in London during a 72-hour stoppage in a row with the government over pay. Photo: DPA
Striking junior doctors from British Medical Association take part in a rally in Parliament Square in London during a 72-hour stoppage in a row with the government over pay. Photo: DPA

In retrospect, the first phase of central banks’ tightening campaigns, in which they raised rates to high enough levels for inflation to start falling, was relatively straightforward. The next phase – doing what it takes to bring inflation back to the 2 per cent target – involves uncomfortable trade-offs. It is not for nothing that the Bank for International Settlements describes this as “the last mile” of the disinflation process.

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