Of inflation, recession, and rate hikes

Of inflation, recession, and rate hikes

As the global economy approaches recession with cuts to GDP forecasts across the board, central banks and governments must now grapple between rising inflationary pressures – several-decades-high inflation in some economies – and a major slowdown in growth

The International Monetary Fund’s October update finds that “global growth is forecast to slow from 6.0 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023. This (would make it) the weakest growth profile since 2001 except for the global financial crisis and the acute phase of the COVID-19 pandemic.”

Market growth expectations from economists polled by Reuters posts an even lower number – at 2.9%, down marginally from the 3% expected in July. Forecasts for 2023 have seen a comparatively sharper slowdown – down from the 2.8% in July to 2.3% currently.

A New Recession Template?

A noteworthy aspect in the oncoming recession, according to economists polled by Reuters, comes from unemployment forecasts. The unemployment rate, a number which usually soars during periods of recession, is expected to rise comparatively lower compared to previous downturns.

‘Indeed”, Reuters reports, “the latest poll expects the smallest gap between growth rates and joblessness in at least four decades.”

Figure 2: The gap between GDP and unemployment projections is set to be the least for a recessionary period in at least four decades; Source: Reuters

“But while that might deaden the intensity of recessions – mostrespondents say it will be short and shallow in key economies – thatmay also keep inflation elevated for longer than most currently expect.”

Global Central Banks playing Catch up

Global central banks, especially those in developed economies – such as the US Federal Reserve, the European Central Bank, and the Bank of England – were rather late to act on the high-inflation problem and are now struggling to control what has essentially spiralled into a cost-of-living crisis in several of these economies. This has forced them into raising interest rates in larger increments than seen for at least a few decades.

In an ideal scenario, you’d want your central bank’s interest rate to be in line with the country’s inflation rate ensuring that no excess price pressures are placed on consumers. This is, however, hardly the case in most economies currently, with the United States, for example, reporting an 8.5% inflation rate and only a 3.25% interest rate.

In India, the inflation rate is currently at 7.4%, up almost 150 basis points from the RBI’s repo rate of 5.9%.

Owing to how late they started, central banks globally are now trying to frontload a number of rate hikes to bring an inflation number already laden with several exogenous shocks such as the COVID-19 pandemic, the supply chain crisis, war in Ukraine, shooting up of energy costs – all things out of their control – back down to their respective mandated levels.

Figure 3: Major drivers of inflation; Source: IMF

The trouble with this, of course, is that repeated rate hikes in quick succession are a double-edged sword and bring with it the grim prospect of a considerable slowdown in economic growth – reflected in the slashing of GDP forecasts for almost all major economies.

However, “most economists and central banks are of the view there will be little work left to do next year,” Reuters reports. “a majority of the top global central banks are over two-thirds of the way to the expected terminal interest rate, but with inflation still much higher than their mandates, the risk is that rate expectations are too low.”

Figure 4: Key global central bank interest rates; Source: Reuters

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