Inflation Worse Before it Gets Better?

After underestimating the worst inflation outbreak in decades, central banks are now driving their economies headlong toward recession in order to tame prices. For now, central banks across many advanced and emerging economies have little option but to keep on hiking in the face of inflation that has yet to peak. Bloomberg Economics sees global inflation edging up from 9% year-on-year in the second quarter to 9.3% in the third quarter before slipping back to a still uncomfortable 8.5% by year end.
The speed of tightening is making a soft landing harder to achieve. Citigroup Inc. economists put the chances of a global recession at 50% while Bank of America Corp. economists forecast a “mild recession this year” in the US as conditions have deteriorated much more rapidly than they expected.
The stark outlook is stoking fears that policymakers will end up overreaching as they push ahead with aggressive interest-rate hikes, just as some now concede they overstimulated through the pandemic recovery.

Investor confidence that policymakers can avoid recession has collapsed. Global growth and profit expectations are at an all-time low while recession expectations are at their highest since the pandemic-fueled slowdown in May 2020, according to Bank of America’s monthly fund manager survey.
While labor markets remain strong, central bankers will still need to tread carefully, said Dario Perkins, global macro strategist at TS Lombard.
“We’re on this rapid path to over-tightening,” he said. “The worry is that having been embarrassed by inflation, policymakers now want to make amends and the risk is they go too far and cause unnecessary damage to the world economy.”

Some officials are already voicing concerns about the pace of rate hikes. They include Federal Reserve Bank of Kansas City President Esther George, who cautioned this month that rushing to tighten policy could backfire.
The European Central Bank raised its key interest rate by 50 basis points, the first increase in 11 years and the biggest since 2000. That came as the likelihood of a contraction has increased to 45% from 30% in June, according to a Bloomberg survey of economists.
The Bank of England is considering a 50 basis points move and the Federal Reserve on July 27 is expected to raise rates by another 75 basis points. The Bank of Canada has already shocked with a 100 basis points move.
Among emerging economies, the South African Reserve Bank lifted its rate by 75 basis points, its biggest increase in borrowing costs in almost two decades, while the Philippines this month surprised with a 75 basis points hike in an unscheduled decision.
Having missed the inflation build-up, monetary officials now face an uphill battle to restore confidence.
In the UK, BOE Governor Andrew Bailey has had to defend against attacks from politicians in the ruling Conservative Party who blame the bank for moving too slowly on inflation. Sweden’s Riksbank Governor Stefan Ingves this month admitted that the bank has had a “bad year” as a forecaster after a ninth consecutive month of inflation exceeding its forecast.
Australia’s government has announced a review of the Reserve Bank amid criticism of the institution’s recent performance. In a rare mea culpa, RBA Governor Philip Lowe on Wednesday conceded that its over stimulus in the pandemic’s wake had added to price pressures.
“While this approach meant we avoided some damaging long-term scarring, it has contributed to the inflationary pressures we are now experiencing,” he said in a speech.
That leaves him, like so many peers, having to trade off economic growth to rein in prices.
“Inflation is expected to get worse before it gets better,” Ravi Menon, managing director of the Monetary Authority of Singapore, said at a briefing on July 19. “A slowdown in economic growth is necessary” to restore global stability. In a warning for central banks about what lies ahead, analysis by Citigroup of the Fed’s hiking cycle between 2015 and 2018 found the economy slowed more rapidly than the Fed expected -- “a powerful reminder that the Fed will need to stay light on its feet and prepare for surprises.”