Interest rates

The global economy is on the verge of diverging in the era of high interest rates – Analysis – Eurasia Review

By Wei Hongxu*

Global inflation has continued to climb throughout this year, posing a serious obstacle to economic recovery and development in all countries.

According to ANBOUND researchers, this has placed central banks around the world in a dilemma: should they keep interest rates low to continue to drive the economic recovery, or should they raise rates to meet policy targets? monetary policy inflation? For now, the Federal Reserve, the most influential central bank in the world, has already made up its mind to adopt an unconventional tightening pace. The European Central Bank (ECB) has also started the pace of reducing accommodation. Meanwhile, the Bank of Japan (BOJ) remains true to its current accommodative policy. However, in market terms, the US Treasury yield has already crossed the 2.0% mark and most European sovereign debt has also moved away from negative long-term interest rates. In Japan, on the other hand, the BOJ continued to intervene in the market to limit a run-up in government bond yields. Changes in the interest rate market are generally expected to cause global inflation to rise in the future. As real yields remain low in the face of record inflation, nominal interest rates are moving away from “zero interest” and “negative interest”, sending the global market into an era of unprecedented high interest rates in the over the past 30 years.

Agustin Carstens, managing director of the Bank for International Settlements (BIS), warned that rising price pressure could keep inflation in many countries at its highest level in more than 30 years and pose problems for long term to central banks. There is evidence, according to Carstens, that consumer and business expectations are “moving away” from record lows and heading into a “new inflationary era”. Carstens estimates that almost 60% of developed economies now have inflation above 5%, the highest level since the 1980s, while more than half of emerging countries have inflation above 7%, the highest level. high since the 2008 financial crisis. Carstens said: “adjustment to higher interest rates will not be easy (for households, businesses, investors and governments)”, “it will be difficult to move to more normal levels for rates and to set realistic expectations about the effects of monetary policy in this process.

The persistence of high inflation recalls the era of “stagflation” triggered by the oil crisis. For the time being, with the Russian-Ukrainian crisis accelerating the transformation of the energy landscape and pushing up the prices of raw materials, inflation, which was thought to be “only for a while”, should exceed the expectations of the policy makers. It also means that inflation becomes the main concern of central banks, which must adopt tightening policies, thus pushing up interest rates. This action is sure to affect demand and the highly inflated capital market and could even lead to a new crisis. Carstens also admitted that “the necessary change in central bank actions will also not be welcome.”

According to ANBOUND researchers, as countries enter the policy tightening cycle one after another, the different pace of policies and economic recovery across countries will cause the economy to diverge. world and turbulence in the capital market. This change will leave the global economy turbulent, complex and volatile. Among them, the most affected will still be emerging and underdeveloped countries. At the moment, we can see that the consumption and employment data show that the momentum of the US economic recovery is still strong, and the Fed has already started raising interest rates and is expected to start raising them. drop in May. This rate of tightening is unusual. Nevertheless, according to the Fed’s expectations, the fall in inflation may not be achieved in the short term, so that the United States may face the situation of “double high” of high economic growth and inflation. high. In Europe, the ECB is believed to have a more complex approach to policy decisions. Indeed, the possibility of Europe falling into “stagflation” is greater because their economic growth has not recovered quickly, coupled with the impact of the Russian-Ukrainian conflict. The situation in China and Japan is different but similar in that central banks in both countries need to adopt accommodative policies at different levels in response to slow economic growth.

In this case, the risks are amplified for other emerging markets and developing countries in general, which cannot determine their monetary policy. Rising interest rates force countries or regions that have incurred external debt to face higher interest charges, and countries with weaker external accounts will initially face pressure from capital outflows and devaluation. The current situation in Sri Lanka is a clear example. While some resource-exporting countries would still benefit from current distortions in global supply chains, some countries that are known for their manufacturing and dependent on exports face upstream and downstream pressures and challenging prospects.

The difference in the policies of the major central banks has led to a widening of the spreads between the major currencies and this is the situation that was not seen in the era of “zero interest rate” or “interest rate”. ‘negative interest’ in the past. The dollar index is approaching 100, while major international currencies such as the euro and the yen have depreciated somewhat. Widening currency spreads will inevitably lead to capital flows between markets. This is not good news for the stability of the economy, nor beneficial for the capital market, and it will surely increase the divergence and the difference in economic growth. Global capital flows at high interest rates point to an era of turbulence and even a repeat of the “stagflation” that has occurred in the past.

*Wei Hongxu, ANBOUND researcher, graduate of Peking University School of Mathematics and PhD in Economics from University of Birmingham, UK