It's a game of chess.
That's how RBI Governor Shaktikanta Das recently described his next move on interest rates in the ongoing battle against inflation.
Like Das, all global central bankers are deeply engaged in a tough and seemingly endless round of chess. In the art of setting interest rates, monetary policymakers are expected to be well ahead of the game, which is to raise and/or cut rates before inflation hurts us.
But it was inflation -- central banks' nightmarish opponent -- that came well-prepared to the fight with persistent price rise in tow. Regrettably, monetary authorities dismissed the incoming price onslaught as 'transitory' and instead of charging ahead with the most aggressive chess move called the king's gambit, they faltered and landed us with the twin evils of high inflation and high interest rates.
In hindsight, it's an era-defining error and as central banks ram through rate hikes to undo the damage, growth is just a hair's breadth away from recession. Any more rate hikes will be as good as forward gears taking an automobile backwards.
According to the Bank of International Settlements, global central banks, as it is, heaved more rate hikes since 2021 than even during the 1970s inflationary oil price shock. In all, the G10 central banks raised rates by 3,765 bps between 2022 and now, while the total hike tally across emerging markets stood over 8,800 bps.
If 2022 was one of the most consequential years in central banking history, thanks to the unprecedented rate hikes, 2023 offered hopes of rate cuts as global inflation showed signs of easing and growth drag became visible in some countries.
As we course through July, that juicy middle month of the year apt for stock taking, the anticipated return of rate cuts, cementing a turn in monetary tightening, a pivot as they call, appears doubtful. Major central banks were on track to hit peak interest rates within the next few months, Morgan Stanley noted earlier this year, adding that they will likely pause for an extended period before easing.
The endgame for all is similar -- touch a peak, take an extended pause and then begin rate cuts. But economies that saw inflationary peaks, and paused rate hikes, saw prices rising again, which forced them to raise rates instead of easing. In central banking jargon, it's called a premature liftoff. For instance, the Bank of Canada raised rates to a 22-year high of 4.75% citing inflationary pressures last month, ending its five-month pause period. Likewise, Australia's central bank, which too paused in April, raised rates both in May and June, with additional warnings about further tightening.
Now, the direction of global interest rates and inflation doesn't seem uniform with various central banks at different points in their cycles. As for emerging markets say from Brazil to Indonesia, a pivot toward rate cuts could start as early as this year, while advanced economies may keep high rates for longer.
But even within emerging markets, there are some stark outliers.
Take Turkey. Its central bank under new governor Hafize Gaye Erkan, in her very first review, delivered a gravity-defying 650 bps rate hike, taking the policy rate to 15% last month. Turkey's annual inflation was just below 40% in May after touching a 24-year high at 85% in October 2022. Prior to Gaye, the country stuck to monetary easing with the one-week repo rate dropping to 8.5% from 19% in 2021, notwithstanding soaring inflation. For a world that's used to the traditional 25 bps hikes, a 50-75 bps hike seemed like an overkill. So a 650 bps hike only indicates that a determined central bank lacks all limits if the objective is to tame the inflation beast.
Turkey's 650 bps was the second biggest rate hike after Russia, which delivered an emergency 1,050 bps, or 10.5 percentage point rate hike, taking the key policy rate from 9.5% to 20% following its invasion of Ukraine in February 2022. Mercifully, it began correcting rates within two months and it now stands at 7.5%.
Likewise, another country delivering jumbo rate hikes to curb soaring inflation is the crisis-hit Pakistan. Last month, it announced yet another 100 bps increase taking its benchmark policy rate to 22%. Its central bank has now raised key rates by 12.25 percentage points since April 2022. As recently as March, the State Bank of Pakistan raised its key policy rate by 300 bps to a 27-year high of 20% -- the highest in Asia. But both Turkey and Pakistan's inflationary pressures have much to do with internal factors rather than external pressures.
Then there are countries that are at the other extreme, cutting rates to support growth. The biggest outlier is Japan, which retained its ultra-loose monetary policy this week. The Bank of Japan’s short-term interest rate target has been held at -0.1% since it first adopted negative rates in 2016 to fight chronic deflation. The current ultra-loose policy is expected to help cope with the country's fragile growth. As Bank of Japan Governor Kazuo Ueda observed, "We haven’t had any serious monetary tightening in 30 years. So in terms of that, the lag in monetary policy could be at least 25 years.”
Similarly, China too eased rates by 10 bps last month, though many argue the reduction will barely move the needle. The People's Bank of China reduced its one-year loan prime rate (LPR) by 10 bps from 3.65% to 3.55% and reduced the 5-year rate by 10 bps to 4.2%, for the first time in 10 months to boost sagging growth as the world’s second largest economy falters.
A report by IMA Asia believes that quite a few Asian countries are expected to cut rates ahead of the US Fed and towards the end of 2023. In contrast, advanced economies seem to be somewhat at odds with their Asian peers.
In June, the G10 central banks delivered the biggest number of monthly interest rate hikes year-to-date and flagged more tightening. As per Reuters, seven out of the nine central banks hiked rates. Both Norway and the Bank of England surprised markets last month with a larger-than-expected 50 bps move, while Canada and Australia resumed rate hikes. Sweden, Switzerland and the European Central Bank (ECB) also tightened policy, taking the total monthly tally of hikes to 225 bps in June. It even confirmed further rate hikes in H2, 2023 before switching to a string of rate cuts in 2024.
In fact, at a panel discussion last month involving the US Federal Reserve chairman Jerome Powell, ECB's Christine Lagarde, Bank of England's Andrew Bailey, and others broadly agreed that interest rates may stay high until inflation bottoms out. Separately, at another ECB Forum held in June, IMF Deputy Managing Director Gita Gopinath too confirmed the bad news about inflation. "The first uncomfortable truth is that inflation is taking too long to get back to target. This means that central banks, including the ECB, must remain committed to fighting inflation (read more rate hikes) despite risks of weaker economic growth."
But it was only a year ago or so that many believed inflation will remain obedient and formed a consensus, like a thick layer on boiled milk. They were proved wrong and whether emerging markets will follow the lead of advanced economies on rate hikes will be keenly watched.
As economist Shaun Richards rightly observed, "The one thing that's persistent is the failures of central banks. Monetary policy now seems to be set more to cover up their past failures than to achieve anything...What central banks demonstrated over the past couple of years was that they have no grip on inflation trends. So moving to a derivative of it is even worse. Indeed it sets the ground for another policy error."