The crunch in the supply chain affected by covid lockdowns has pushed the global economy’s inflation at a rate faster than expected. This has put the Central Banks into a dilemma whether to raise interest rates or not.
As per Bloomberg news, Central Banks may be forced to respond even if it remains to be seen how much imbalance they can fix, which currently seems to be beyond tier control.
The resurgence in demand after the opening up post lockdown may have driven the inflation through the supplies are choked at ports jammed due to shortage of workers and materials.
Rising interest rates can help offset inflation, but the demand looks a little tempered despite the supply bottlenecks. If the rides return to normal as shortages are expected to ease, the Central Banks could find themselves in a tight corner.
If the Central Banks still hold back and the supply crisis continues, the inflation is expected to go up further, prompting the employers to push up wages and companies to increase prices. In such a scenario central bank may be forced to hit the brakes.
As per Bloomberg Television, the senior economic advisor of HSBC Holdings, Stephen King, said, “Right now, it is challenging to balance the demand and supply drivers”. Most Central Banks will admit, though privately, “why the inflation is much higher than it was expected“.
Time to act
As per JP Morgan Chase and Co, consumer prices have risen by 4%+ in the last 12 months globally. Inflation beyond food and energy has been at its highest in the past decade.
Bank of England’s Governor Andrew Bailey has warned that Central Banks will have to act, given that his own Bank of England target of inflation exceeded by double in 2021.
Still, he highlights that there is a limit to what Central Banks can achieve.
Traders speculate that the Bank of England will raise its key lending rates by 0.5 % by the end of 2021. This would place them alongside New Zealand and Norway, which has increased borrowing costs as a smaller developed economy during the pandemic.
The federal reserves of the US are not expected to join the club soon, but they are poised to do so next month as they have to narrow its $120 billion asset purchase program every month. Jeremy Powell, Chair of Federal reserves, feels that the asset purchase program is not linked to the interest rate hikes. The other policymakers are clamoring for ending bond purchases so that there is some scope to boost interest rates next year.
The federal reserve feels that the factors which have led to increased inflation are due to temporary factors. The September meeting saw them tilt the risk towards the upside. Investors are, however, gearing up for a quarter-point increase in two tranches next year.
PGIM Fixed Income’s multi-sector and strategy Head, Greg Peters, is skeptical about how much the interest raise can counter the inflation rise, considering the supply chain bottlenecks. He told Bloomberg Television that he is not convinced that the Federal reserve can control these issues. He questions how the federal can fix inflation or supply chain issues just by raising the interest rates. This move can crush the labor market, feels Greg Peters.
The European Central Bank (ECB) is counting on its previous experience in 2008 and 2011 when it overreacted and raised the rates.
They ultimately had to do an about turn as the economy slowed down then. The president of the ECB said that the inflation spike is not expected to last.
This view was also shared by Yi Gang, Governor of the Bank of China. The production-led price inflation which has hit a high over the last 25 years, will mellow down by the end of 2021. The IMF said that inflation pressure in advanced economies will unwind in 2022.
Business leaders are, however, warning that the inflation pressure will continue. The shortage of semiconductors supply has made Royal Philips NV revise and lower its growth, and earnings sales are affected. CEO Frans Van Houten feels that though inflation will subside, the human resource cost will remain high.
Neil Dutta of Renaissance Macro Research says that if supply disruptions and strong demand continue, the central bank will face more risk.
