Federal Reserve Board Chairman Jerome Powell delivers a news conference after the Fed hiked interest rates by a quarter of a percentage point following a two-day Federal Open Market Committee (FOMC) meeting on interest rate policy March 22, 2023 in Washington.
Leah Millis | Reuters
Following JPMorgan Chase’s bailout of First Republic Bank over the weekend, leading economists believe a prolonged period of higher interest rates will expose further weaknesses in the banking sector and potentially threaten central banks’ ability to contain inflation.
The US Federal Reserve will announce its latest monetary policy decision on Wednesday, closely followed by the European Central Bank on Thursday.
Central banks around the world have been aggressively raising interest rates for over a year in a bid to curb soaring inflation, but economists have warned in recent days that price pressures are likely to persist.
The outlook report by the WEF’s chief economists, released on Monday, stressed that inflation remained a key concern. Nearly 80% of the chief economists surveyed said central banks face a “compromise between managing inflation and maintaining financial sector stability,” while a similar proportion expect central banks will struggle to meet their inflation targets.
“Most chief economists believe that central banks have to walk a very delicate dance between the desire to keep inflation down and the financial stability concerns that have also surfaced in recent months,” Zahidi told Monday CNBC.
As a result, she explained, the tradeoff will be more difficult to manage as around three-quarters of the economists surveyed expect inflation to remain high or that central banks cannot act fast enough to bring it down to target.
First Republic Bank became the latest victim over the weekend, third among mid-sized US banks after the sudden collapse of Silicon Valley Bank and Signature Bank in early March. It was like this this time JPMorgan Chase That came to the rescue: The Wall Street giant won a weekend auction for the ailing regional lender after it was seized by California’s Department of Financial Protection and Innovation.
CEO Jamie Dimon claimed the decision marked the end of recent market turmoil as JPMorgan Chase acquired almost all of its deposits and much of its assets from First Republic.
Still, several leading economists said Tuesday before a panel at the World Economic Forum’s growth summit in Geneva that higher inflation and greater financial instability will persist.
“People haven’t adjusted to this new era, that we’re going to have an era that’s going to be structurally more inflationary, a post-globalization world, where we’re not going to have the same level of trade, there’s going to be more barriers to trade.” The older demographic means the retirees who are savers aren’t saving in the same way,” said Karen Harris, managing director of macro trends at Bain & Company.
“And we have a declining workforce, which requires investment in automation in many markets, so less capital generation, less free movement of capital and goods, more demand for capital. That means inflation, the inflationary stimulus, will be higher.”
Harris added that this doesn’t mean that actual inflation will be higher, but that real (inflation-adjusted) interest rates need to be higher for longer, which she says poses “a big risk” because “the calibration to …” A low-rate era is so ingrained that becoming accustomed to higher rates, this torque, will result in failures we have not yet seen or anticipated.”
She added that it “breaks logic” that there will be no more losses other than SVB, Signature, Credit Suisse and First Republic as the industry tries to quickly transition to a higher interest rate environment.
Jorge Sicilia, chief economist at BBVA Group, said after the abrupt rise in interest rates over the past 15 months or so, central banks would likely want to wait and see how this monetary policy shift affected the economy. However, he said a bigger concern is possible “nests of instability” that the market is currently unaware of.
“In a world where debt has been very high because interest rates have been very low for a long period of time, and where liquidity will not be as plentiful as it was before, you won’t know where the next problem is going .”,” Sicilia told the panel.
He also referred to the reference in the International Monetary Fund’s recent Financial Stability Report to the “intertwining” of debt, liquidity and these zones of instability.
“If the interconnectedness of the pockets of instability doesn’t affect the banking system, which normally lends, this need not be a significant problem and central banks can therefore continue to focus on inflation,” Sicilia said.
“That doesn’t mean we won’t have instability, but it does mean that if inflation doesn’t get down to levels close to 2 or 3% and central banks are still there, it’s going to get worse in the future.”