Analysis: The Pain of Breaking Down Inflation Resonates Around the World

JACKSON HOLE, Wyo. (Reuters) – The message from the world’s top financial executives is crystal clear. Inflation will continue and will require tremendous efforts to contain it. emerging market.

However, that price is still worth paying. Central banks have spent decades building confidence in their skills in fighting inflation, but losing this battle could shake the foundations of modern monetary policy.

European Central Bank Governor Isabel Schnabel said: “Inflation needs to return to target quickly to restore and maintain confidence.” “The longer inflation stays high, the greater the risk that public confidence in our determination and ability to maintain purchasing power will be lost.”

Banks have to survive even as growth slows and people start losing their jobs.

“Even if we do get into a recession, we basically have little choice but to continue on our policy path,” Mr. Schnabel said. “If inflation expectations dissipate, the economic impact will be even worse,” he said.

Inflation is nearly in the double-digit range in many of the world’s largest economies, levels not seen in nearly half a century. Except for the US, the peak is still months away.

The problem is that most of the time central banks seem to have limited powers.

For one thing, high energy prices due to Russia’s war in Ukraine are creating a supply shock that monetary policy has little impact on.

High spending by governments outside the control of central banks also exacerbates the problem. A study presented in Jackson Hole argued that half of US inflation is caused by fiscal policy, and that the Fed cannot control prices without government cooperation.read more

Finally, a new inflation regime may be in place, which will maintain upward pressure on prices for an extended period of time.

Deglobalization, alliance restructuring due to Russia’s war, demographic shifts and more expensive production in emerging markets can all make supply constraints more permanent.Read more

Bank for International Settlements (BIS) President Agustín Carstens said: “The global economy appears to be on the brink of a historic change. The aggregate supply tailwinds that have kept inflation in check are about to turn into headwinds.”

“If so, the recent rebound in inflationary pressures could prove more persistent,” said Carstens, who heads a group often called the central bank of central banks in the world. .

All of this points to rapid rate hikes led by the Fed and rate hikes that the ECB is now trying to catch up with and rate hikes over the next few years.

emerging markets

The pain of high U.S. interest rates will reverberate well beyond the U.S. economy, and will hit emerging markets hard, especially if high interest rates prove to be as persistent as Powell is now.

“This is a critical time for the Fed,” said Peter Blair Henry, professor emeritus and dean emeritus of the New York University Stern School of Business.

“The credibility of the last 40 years is at stake and anything will keep inflation down, including whether that means collateral damage in emerging markets.”

Many emerging market economies borrow in dollars, and the Fed’s interest rate hike hits them on multiple fronts.

That drives up borrowing costs and creates debt sustainability issues. It also brings liquidity to U.S. markets, driving up risk premiums in emerging markets and making borrowing more difficult.

Finally, the dollar will continue to appreciate against most currencies, boosting emerging market import inflation.

While big countries such as China and India seem isolated enough, many smaller ones, from Turkey to Argentina, are clearly suffering.

“We have many particularly frontier economies, with spreads widening to what we call distressed or near distressed levels in low-income countries,” said IMF chief economist Pierre-Olivier Gourintjas. So 700 basis points to 1,000 basis points.”

“There are a large number of countries, about 60% of low-income countries, and about 20 emerging and frontier economies in the picture,” he said. “They still have access to the market, but certainly borrowing terms have deteriorated significantly.”

S&P Global’s monitors currently consider lenders in South Africa, Argentina and Turkey to be at high or very high funding risk. We also see high or very high credit risk for financial institutions in many countries, including China, India and Indonesia.

“There are some frontier economies like Sri Lanka and Turkey that would be hit if the Federal Reserve raises rates and they stay high,” said Eswar Prasad, an economics professor at Cornell University. said.

“The outlook for the next two to three years is going to start to get tougher … pressures could quickly be knocked off if it becomes clear that the Fed will keep interest rates high for an extended period of time,” Prasad added.

Additional reporting by Ann Saphir.Editing: Dan Barnes, Chizuru Nomiyama

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