The frontrunner
Of all the major central banks, the Federal Reserve was the first to raise interest rates this year. On Wednesday that happened for the fifth time, and for the third time in a row it was a strong increase of 75 basis points. As a result, the policy rate has ended up in a bandwidth between 3 and 3.25 percent, and thus above the so-called ‘neutral interest rate’. That rate, at which the Federal Reserve neither boosts nor slows down the economy, is estimated at 2.5 percent.
Yet the interest rate is not nearly high enough to quarter the current high inflation in the direction of the desired 2 percent. Federal Reserve Chairman Jerome Powell emphasized that the Fed will do whatever it takes to achieve that goal. In other words, there will be more interest rate hikes. Fed officials expect interest rates to reach 4.4 percent by the end of the year.
Powell said it would take a period of “much lower growth” and a cooling of the “extremely tight” labor market to ease pressure on ever-higher prices. If the central bank’s policies push the economy into recession, so be it, Powell made clear. “I wish there was a painless way to bring inflation back under control, but there isn’t one.” The Fed expects unemployment to rise from 3.7 percent in August to 4.4 percent by the end of 2023.
The peloton
Many central banks have stepped up a gear this week in their fight against the major currency devaluation. Normally they are very cautious about raising interest rates for fear of unnecessarily bruising the economy, but not now. Instead of increasing by 25 basis points, they added 50 or even 75 basis points this week. The first group included the Norwegian and British central banks, as a result of which the interest rate in both countries went to 2.25 percent.
Another holy grail of modern central bankers fell, namely maximum policy predictability. This was the case, for example, with the Swedish Riksbank. The world’s oldest central bank announced an interest rate hike of a full percentage point (or 100 basis points) on Wednesday. Financial markets had expected an increase of ‘only’ 75 basis points. ‘Inflation is for high‘ was the statement from the Riksbank. Inflation is too high, and so monetary policy must be stricter.
Deep in the belly of the pack, the Swiss shook his legs awake on Thursday. The Swiss central bank (SNB) decided to raise interest rates by 75 basis points to 0.5 percent. This means that interest rates in the Alpine country are no longer the lowest in the world. For nearly eight years, banks that wanted to deposit money with the SNB had to pay for that privilege, rather than getting a fee for it. In August, Swiss inflation rose to 3.5 percent.
A lot lower than in neighboring countries, ING economists Charlotte de Montpellier and Chris Turner note, ‘thanks to a more favorable energy mix, a lower share of energy in consumption, and the strong Swiss franc discouraging imports’. They expect more rate hikes to follow, as the SNB’s inflation target is between 0 and 2 percent. That is possible in December at the earliest, as the Swiss central bankers only take an interest rate decision once a quarter.
For the European Central Bank, that is every six weeks. Frankfurt did not play this week. On September 8, the ECB raised interest rates for the second time this year. At 75 basis points, this was the largest interest rate rise since the introduction of the euro more than twenty years ago. ECB President Christine Lagarde immediately announced the next interest rate hikes. Here too, this is happening against the background of a possible recession. Deutsche Bank analysts revised their economic outlook for the eurozone downward this week. They now assume a contraction of 2.2 percent next year, while inflation will remain stubbornly high at 6.2 percent.
Maurice Obstfeld, former chief economist of the International Monetary Fund, points out a contribution for the American think-tank Peterson Institute that the pack of central banks can make an avoidable tummy tuck. “The current danger is not so much that their measures will ultimately fail to curb inflation. It is that they collectively go too far and push the world economy into an unnecessarily hard contraction.’ He fears that central banks are underestimating how quickly inflation can fall if their economies cool down. ‘By all moving in the same direction at the same time, they risk amplifying the consequences of each other’s policies, especially in a very globalized world economy.’
the surplace
While just about all riders are speeding up, the Japanese central bank once again kept its legs still on Thursday. For about three decades, the Japanese economy has been flirting with deflation, a situation characterized by falling prices. The central bank conducted an unprecedented monetary expansion over that period in hopes of creating inflation and economic growth, which seemed to fail. Now that it’s finally here – inflation was 3 percent in August – the Nippon Ginko doesn’t want to nip it in the bud. The interest rate therefore remains at -0.1 percent.
The Brazilian central bank also did not change interest rates this week, but that was after twelve consecutive hikes that had pushed interest rates to 13.75 percent.
the ghost driver
Yet it is not Japan, but Turkey that is the strangest rider in the pack. There, the central bank cut interest rates by a full percentage point to 12 percent on Thursday. According to the unorthodox and inimitable reading of Turkish President Recep Tayyip Erdogan, higher interest rates lead to higher inflation, not lower. If the governor of the central bank dares to think otherwise, he can immediately pack his things.
In August inflation in the country was 80 percent compared to the same month a year earlier. According to experts, that official figure is still a gross underestimate of reality. The Turkish lira has fallen to a record low against the dollar.