Fighting Inflation- Whatever it Takes?!

Sep 20, 2022 Dieter Adam

Markets are expecting the US Federal Reserve Board to stick to its guns and raise interest rates to between 3% and 3.25 %. That’s another 0.75% increase and has already driven 10-year US treasury bond rates to an eleven-year high.

Such a rise would find the support of the of the BIS (Bank of International Settlement: “Our mission is to support central banks’ pursuit of monetary and financial stability through international cooperation, and to act as a bank for central banks”), the éminence grise of the international financial system – not often talked about, but hugely influential in the background.

In its quarterly report published on Monday, the BIS once again spoke out in favour of decisive action by central banks in the fight against inflation, even if this increases the risks of recession and debt crises. BIS chief Agustín Carstens had already warned weeks ago at the central bank meeting in Jackson Hole, USA, that deglobalisation and demographic trends could make production in emerging markets more expensive and lead to permanent supply chain bottlenecks.

Trying to prevent a hard landing

In their latest quarterly report, BIS Chief Economist Claudio Borio attributed the recent wave of selling on international financial markets to the rude awakening of investors. They had been over-confident in the summer months about the solution to the economic problems and have now realised that the central banks would fight the stubborn inflation without regard to financial risks. Borio believes it is necessary for monetary policy to take timely and decisive action against inflation. Then the rate hikes could reduce the likelihood of a hard landing for the economy.

But the BIS chief economist also sees risks for central banks. This is the first time since World War II that monetary policy has had to fight accelerating inflation, while debt crises are occurring and concerns about overvalued real estate markets are growing. Apart from concerns about private debt, public debt levels across the G-7 countries have risen from 84% in 2007 to 140% at the end of 2021, and that value will go up further as European countries go further into debt to soften the impact of rampant energy prices on their citizens.

Claudio Borio acknowledged that the risk of recession has increased, speaking of a “very narrow path” for central banks to tread. The BIS describes the environment contributing to the sharp market swings as the economic fallout from the Ukraine war, weaker economic activity in China, rapid monetary tightening and the energy crisis in Europe. It also blames these factors for the unusually rapid rise in the dollar exchange rate against the euro and the Japanese yen.

In a special article in its quarterly report, the BIS authors warn of the consequences of the embargo on Russian oil supplies. Replacement could become difficult for Western countries. A restriction on Russian oil exports is likely to be accompanied by sharp and prolonged price increases, the BIS economists expect. In addition, there could be effects on other areas such as food prices. This would be the case if biofuels were increasingly used. This could push up the prices of various staple foods that would be needed to produce the biofuels.

So, the BIS spreads doom and gloom – and they’re not the only one – while we are (almost) all as busy as a one-armed paper hanger in manufacturing in New Zealand. It’ll take a cour­ageous (wo)man to predict how this will all go over, say, the next five years.