KUALA LUMPUR – Fears of runaway inflation are at the heart of monetary tightening moves, while Russia’s invasion of Ukraine is smashing the global economy’s already snarled supply chains, said Moody’s Analytics.
The financial services company, in a report titled “There’s More to Monetary Policy Than Inflation”, said squirrelled away savings and big pandemic stimulus spending by governments are adding to demand.
“More than that, border restrictions are preventing the free movement of labour, lumping wage pressure on key job markets such as the United States.
“More interest rate rises are guaranteed. But just how quickly central banks move and how high they go relies on a myriad of competing priorities,” it said.
The combination of supply frustrations and heightened demand is pushing inflation to multi-decade highs. The cost of living is rising and real wages are going backwards in many economies.
Moody’s Analytics said if expectations of runaway inflation creep into the community’s mind, firms will set their prices as if inflation fears have already eventuated.
Not wanting to get caught short by the prospect of future price rises, a price spiral can take hold that is hard to stop.
“Central banks must manage this risk. And they’ll have a close eye on movements in the 10-year breakeven rate – the difference between yields on 10-year nominal treasury bonds and those on 10-year treasury inflation protection securities,” it said.
It explained that when national interest rates go up, investors swarm for a better return, lifting demand for the local currency and strengthening the exchange rate.
The opposite is true when countries are too late or too slow to lift rates relative to the rest of the world.
“In this case, an exchange rate weakens, lifting inflation through higher import costs. That said, at a time when global demand is set to wane, exporting countries could benefit from a weakening exchange rate as it makes their exports more competitive,” it said.
Moody’s Analytics said central banks will need to closely monitor the impact of rate rises on households – going too hard could plunge economies into recession.
“Balancing these considerations is no mean feat, but we’ll need central banks to do just that if we’re to experience the desired soft landing,” it added. – Bernama, June 15, 2022
