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With U.S. markets worried about more aggressive Federal Reserve behavior due to stubborn inflation, the Bank for International Settlements warned that a higher-than-expected global rate hike could not be ruled out.
Claudio Borio, head of the monetary and economic department at the BIS, pointed out that central banks are very clear about getting the job done and are wary of declaring a victory over inflation prematurely.
The latest BIS quarterly report says that central banks will remain hawkish for longer than expected to keep high inflation under control.
According to Borio, it is important for central banks to avoid the mistakes of the 1970s by declaring victory too early.
Markets have fallen over the past few weeks. Investors are reconsidering expectations of an interest rate hike. At the beginning of the year, markets were preparing for rate cuts at the end of 2023. This was based on the idea that the Fed had done enough with its four percentage points tightening cycle.
Now macroeconomic data for January show a strong economy, high employment and still problematically high inflation. This has sparked new expectations that the Fed will raise rates higher and keep them at a higher level.
However, even after the recent sell-off in the market, BIS noted that financial asset prices continue to point to "firm expectation that rate hikes would stop before the end of this year and that policy rates would decline materially in 2024." But that may not be the case, given the "sharp contrast" of central bank messages, "no indication that easing was on the horizon."
Inflation is a problem because it's not falling fast enough. And in some cases, it is accelerating.
The latest update of the Fed's preferred measure of inflation, the annual core PCE price index, showed an acceleration in January, amounting to 4.7% versus the expected 4.3%.
In the Eurozone, core annual inflation, which excludes food and energy price volatility, reached a new record high of 5.3% in January.
The lesson of the 1970s is that inflation can show signs of slowing down but then turn around.
Another complication in the inflation narrative is that changes in monetary policy now have less of an impact on consumer demand, making it harder for central banks to ease price pressures.
The BIS quarterly report also released additional research on how more restrictive monetary policy is affecting financial system stress and debt levels. The report also looks at the relationship between higher commodity prices and a stronger U.S. dollar, with the risk of stagflation.
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