Many economies are approaching a tipping point where high inflation becomes normal while economic growth slows sharply, the Bank for International Settlements warned in its annual report published Sunday.
Countries around the world are facing a dangerous cocktail of high inflation, slowing economic growth and heightened financial vulnerabilities tied to high debt levels and rising interest rates, said the BIS, which acts as a bank for the world’s central banks.
This may quickly turn into a period of stagflation resembling the high-inflation and low-growth era of 1970s and early 1980s, the organization said. It argued that economic policy makers around the world need to move rapidly to halt inflation, even if that means causing significant economic hardship.
“We may be reaching a tipping point, beyond which an inflationary psychology spreads and becomes entrenched. This would mean a major paradigm shift,” the BIS said.
Central banks around the world have stepped up the pace of interest rate increases in recent months to try to tame inflation. Two weeks ago, the U.S. Federal Reserve announced the largest interest rate hike since 1994. The Bank of Canada has increased its benchmark rate at three consecutive rate decisions, and hinted that it is considering a supersized 0.75 percentage point rate increase in July. That would be three times the size of a normal rate hike.
Interest rate increases lower demand in the economy, which can help bring down the pace of consumer price growth. But higher interest rates can also push the economy into a recession, as steeper borrowing costs curtail consumer spending and business investment, and push up unemployment.
“The overriding near-term challenge is to prevent the global economy from shifting from a low- to a high-inflation regime. In doing so, policy makers will need to limit the costs to the economy as far as possible and to safeguard financial stability. Some pain, however, will be inevitable,” the BIS said.
Getting inflation under control won’t be easy, the organization warned. The recent commodity price shock tied to Russia’s invasion of Ukraine has added to multiple inflationary pressures that have been building over the past year. This resembles the oil price shocks in the 1970s that pushed the United States, Canada and other countries into a period of high inflation, high unemployment and low economic growth known as stagflation.
The situation today, however, could be even more dangerous than in earlier periods of stagflation because of the amount of debt – particularly housing market debt – that has built up over more than a decade of ultra-low interest rates, the BIS warned. It called the current combination of soaring inflation and elevated financial vulnerabilities “historically unprecedented.”
“Unlike in the past, stagflation today would occur alongside heightened financial vulnerabilities, including stretched asset prices and high debt levels, which could magnify any growth slowdown,” it said.
As they push interest rates higher, central banks are trying to engineer a soft landing – a situation where inflation comes down without a sharp slowdown in economic activity or significant rise in unemployment. Top central bankers, including Fed chair Jerome Powell and Bank of Canada Governor Tiff Macklem, have said in recent weeks they believe a soft landing is possible, although they acknowledge that it is getting more difficult.
The BIS poured cold water on the probability of a soft landing in its report. BIS economists looked at monetary policy tightening cycles in 35 countries between 1985 and 2018, and concluded that about half of them resulted in a soft landing – that is, did not end in a recession.
However, further analysis showed that recessions were more likely if rate hikes followed a period of ultralow borrowing costs and a build-up of financial vulnerabilities. That is the situation Canada and many other advanced economies are in today.
“A hard landing may not be foreordained,” Columbia University professor Adam Tooze wrote in a newsletter commenting on the BIS report. “But what the BIS is telling us, is that central bankers have never attempted to stop an inflation as rapid as the one we have seen in the first half of 2022, with the level of debt build-up we have seen since the early 2000s.”
The BIS is not alone in its grim prognosis. Earlier this month, the World Bank cut its 2022 global growth forecast to 2.9 per cent from a 4.1-per-cent forecast in January, and said that “the danger of stagflation is considerable today.”
Much of the BIS report focused on the changing dynamics of inflation, which is surging across large parts of the globe for the first time in decades. The annual rate of inflation hit a 39-year-high of 7.7 per cent in May in Canada, the highest since 1983. It averaged 9.2 per cent in April across countries in the Organization for Economic Co-operation and Development.
The BIS noted that once economies shift into periods of high inflation, consumer price increases become self-reinforcing. Businesses and consumers start paying more attention to rising prices and start behaving differently, respectively setting higher prices and demanding higher wages to protect their margins and purchasing power.
“Whether inflation becomes entrenched or not ultimately depends on whether wage-price spirals will develop. The risk should not be underestimated, owing to the inherent dynamics of transitions from low- to high-inflation regimes,” the BIS said.
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German recession fears deepen as economy is hit by 'perfect storm' – Financial Times
Investors are now more pessimistic about the German economy than they have been at any time since the eurozone debt crisis more than a decade ago, worrying that a sharp fall in Russian natural gas supplies and soaring energy prices will plunge the country into recession.
The ZEW Institute’s gauge of investor expectations about Europe’s largest economy has sunk to its lowest level since 2011, dropping from minus 53.8 to minus 55.3, underlining the deepening gloom about the economic fallout from Russia’s invasion of Ukraine.
The think-tank’s survey of financial market participants provides an early indicator of economic sentiment after Russia reopened the Nord Stream 1 pipeline following a maintenance break last month, but kept the main conduit for delivery of gas to Europe operating at only a fifth of capacity.
Economists have slashed their estimates for growth in Germany and the wider eurozone this year, while raising their inflation forecasts and warning that an end to Russian energy supplies would force Berlin to ration gas supplies for heavy industrial users.
On Tuesday, German baseload power for delivery next year, the benchmark European price, rose over 5 per cent to a record €502 per megawatt hour, according to the European Energy Exchange. This is six times higher than the price a year ago — driven upwards by the sharply higher cost of gas used to generate electricity and the prolonged European heatwave that has disrupted generating capacity.
The surging price of energy has driven up the cost of imports for Germany and other eurozone countries, sending the bloc’s trade deficit up to €24.6bn in June, compared with a surplus of €17.2bn for the same month a year earlier, according to data from Eurostat, the European Commission’s statistics bureau. The value of exports from the bloc rose 20.1 per cent in June from a year ago, but imports were up 43.5 per cent.
“The still high increase in consumer prices and the expected additional costs for heating and electricity are currently having a particularly negative impact on the prospects for the consumer-related sectors of the economy,” said Michael Schröder, a researcher at the ZEW.
He said investor sentiment also worsened due to an expected tightening of financing conditions after the European Central Bank raised its deposit rate by 0.5 percentage points to zero in response to record levels of eurozone inflation.
Carsten Brzeski, head of macro research at Dutch bank ING, said the German economy was “quickly approaching a perfect storm” caused by “high inflation, possible energy supply disruptions, and ongoing supply frictions”.
A heatwave and dry spell has reduced water levels on the Rhine below the level at which barges can be loaded fully, restricting important supplies for factories, which Brzeski estimated was likely to knock as much as 0.5 percentage points off German growth this year.
Adding to the gloom, German households will have to pay hundreds of euros more in fuel bills this winter after the government unveiled an extra gas levy of 2.419 cents per KWH from October. This is expected to push up the cost for a family of four by €240 in the final three months of the year.
Germany’s top network regulator told the Financial Times this month that the country must cut its gas use by a fifth to avoid a crippling shortage this winter. The economy ministry has also ordered all companies and local authorities to reduce the minimum room temperature in their workspaces to 19C over the winter.
The country has achieved its target of filling gas storage facilities to three-quarters of capacity two weeks ahead of schedule, after high prices and fuel saving measures led to reduced use. But there are worries its objective to lift gas storage to a 95 per cent target of capacity by November will be more challenging if Russia keeps throttling supplies.
The German economy stagnated in the second quarter, the weakest performance of the major eurozone countries. Last month, the IMF slashed its forecast for German growth next year by 1.9 percentage points to 0.8 per cent, the biggest downgrade of any country.
Additional reporting by Harry Dempsey
Why China's economy is slowing down – Axios
China is slowing fast, and the government is taking only modest steps to try to keep the earth’s second-largest economy from outright contraction.
Why it matters: While it lags behind the U.S. in size, China’s economy has been the largest source of growth for global GDP for much of the last two-plus decades — meaning it’s a global engine of corporate profitability, investment activity, and demand for commodities.
Driving the news: A raft of disappointing economic updates this week showed Chinese growth still sputtering on multiple fronts.
- Its industrial sector slowed again. Industrial production rose just 3.8% in July compared to the previous year — and well short of expectations for 4.5%.
- The crisis in China’s housing sector continues to hurt. Fixed investment — of which housing is an important component — was up just 5.7% in the first seven months of the year, compared to the same period in 2021. (In 2021, that figure was 10.3% higher year over year as of July.)
- Consumers aren’t picking up the slack either. Retail sales in July were up a scant 2.7% year over year, far short of the 5% expectation.
Context: In the recent past, when faced with a slowdown, Chinese policymakers quickly turned to tried-and-true tools to attempt to give growth a kick in the pants. They included…
- Pouring money into public infrastructure investment.
- Engineering a borrowing boom to fuel domestic spending.
- Delivering sharp interest rate cuts.
The intrigue: Despite China’s current economic blahs, there’s little indication that the government is decisively trying to prop growth up.
- In past slowdowns, China’s broadest measure of all types of credit to the economy — known as “total social financing” — has surged, a sign the government was keen to boost debt to offset slumps.
- A report on Friday showed total social financing far lower than expected, as the government seems disinclined to use a debt-driven boom as a source of growth.
Yes, but: The People’s Bank of China did cut interest rates by a tiny one-tenth of a percentage point on Monday — a move most analysts think is modest, and unlikely to reinvigorate economic activity.
The bottom line: The ruling Chinese Communist Party knows that the breakneck pace of Chinese economic growth that prevailed in past decades is unlikely to be matched. But unlike in past decades, they don’t seem particularly worried about it.
- For the rest of the world, that may mean China will be less of a reliable engine of growth in the coming years.
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