Central banks will keep borrowing costs high for long enough to ensure that inflation is brought under lasting control, the Bank for International Settlements has said, as it warned investors were overestimating the chances of rate cuts next year.
“Central banks have been very clear about the priority of getting the job done and of being cautious about declaring victory too early,” said Claudio Borio, head of the monetary and economic department at the BIS. “[This] cautious attitude is the appropriate one.”
The BIS said the pricing of financial assets still signalled a “firm expectation” among investors “that rate hikes would stop before the end of this year and that policy rates would decline materially in 2024”.
This was in “sharp contrast” to cautious communications from rate-setters, which “gave no indication that easing was on the horizon”.
The message from the quarterly bulletin of the BIS, often referred to as the central bankers’ bank, comes as investors become increasingly nervous that rate-setters will raise borrowing costs to higher levels than they hoped — and keep them there for longer than expected.
Market expectations earlier this year were for the US Federal Reserve, which has raised rates by 4 percentage points since last March, to begin cutting rates before the end of 2023 or early in 2024. This view has been challenged in recent weeks by higher than expected US inflation figures and strong jobs data.
A rally in global bond markets earlier this year has crumbled, while stocks have fallen sharply. In the eurozone, where the European Central Bank has raised rates by 3 percentage points since last summer, investors have started pricing in more rate rises over the coming months.
While headline inflation rates have fallen since the autumn on the back of a fall in commodity prices, cost pressures remain far higher than rate-setters would like.
Annual price growth remains several multiples higher than central banks’ 2 per cent goals. In the eurozone, core inflation — which strips out changes in food and energy prices, and is seen as a better measure of underlying price pressures — hit a fresh record high of 5.3 per cent in January.
Borio said it was “much easier to get inflation from 8 per cent to 4 per cent when the work is done by [falling] commodities prices, than it is to get it from 4 per cent to 2 per cent, which is the part that central banks will have to do”.
Hyun Song Shin, the BIS’s head of research, said the lesson of the high inflation of the 1970s was that price pressures could rise again after falling as new shocks materialise.
“The reason central banks have been emphasising [the importance of] going the last mile on bringing inflation down is that, if you are not fully back to target and relax too early, you will undo all the work you have done before,” he said.
He added that there was evidence that consumer demand had become less sensitive to changes in central bank policy rates, making the job of bringing inflation under control harder.
