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Fed to Inflict More Pain on Economy as It Readies Big Rate Hike – BNN

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(Bloomberg) — The Federal Reserve will probably have to inflict much more pain on the economy to get inflation under control.

Growth is already slowing in response to the Fed’s repeated interest rate increases, with the housing market softening, technology companies curbing hiring and unemployment claims edging up.

But with inflation proving persistent at a four-decade high, a growing number of analysts say it will take a recession — and markedly higher joblessness — to ease price pressures significantly.  A Bloomberg survey of economists this month put the probability of a downturn over the next 12 months at 47.5%, up from 30% in June.

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“We have to curb things domestically to help us get where we want to go on inflation,” said Bank of America chief US economist Michael Gapen, who’s forecast a mild recession starting in the second half of 2022.

After raising rates in June by the most since 1994, Fed Chairman Jerome Powell and his colleagues are expected to approve another 75 basis-point hike this week and signal their intention to keep moving higher in the months ahead. Powell has said that failing to restore price stability would be a “bigger mistake” than pushing the US into a recession.

Fed officials though continue to maintain that they can avoid a recession and execute a soft landing of the economy. They argue that the economy has underlying strengths and have voiced hopes that inflation could ease as quickly as it escalated.

Inflation — as measured by the Fed’s favorite gauge, the personal consumption expenditures price index — was 6.3% in May, well above the central bank’s 2% target.

What Bloomberg Economics Says

“The chance of a downturn in the next 12 months has risen to 38%, significantly higher than zero when we ran the model a month ago. The model sees a 100% probability of recession in the next 24 months.”

—  Eliza Winger, Anna Wong and Yelena Shulyatyeva (economists)

— To read more click here

The more popular consumer price index is running hotter: It rose 9.1% in June from a year earlier. Three-quarters of the goods and services in the CPI basket increased at an annualized rate in excess of 4% in June from May.

“Inflation is entrenched and spreading,” said former Fed Vice Chair and Brookings Institution senior fellow Donald Kohn.  

The central bank faces a tricky job because at least some of the upward pressure on inflation is not from excess demand – which it can control – but from supply disruptions that it is powerless to affect stemming from Russia’s invasion of Ukraine and the pandemic.

An added complication, according to ex-Fed Vice Chair Alan Blinder: Monetary policy impacts inflation with very long lags of perhaps two or three years. 

Traders in the federal funds futures market are betting the Fed will raise rates to about 3.5% by year end, from 1.5% to 1.75% now, before beginning to cut them in the latter half of 2023. 

Former Treasury Secretary Lawrence Summers doubts that’s how it will play out. 

“My instinct is that you’d not see rates cut as soon as people think,” the Harvard University professor and paid Bloomberg Television contributor said. 

“The Fed has to be careful. If you look at the history of the 60’s and 70’s, there were moments when monetary policy eased a bit and things didn’t tend to work out so well,” he added, referring to episodes where the Fed loosened credit before stamping out inflation.

Instead of cutting rates, the Fed will likely raise them to 5% or higher next year to try to bring price pressures to heel, Dreyfus and Mellon chief economist Vincent Reinhart said. That will help precipitate a contraction that increases unemployment to about 6%, from 3.6% now, but leaves inflation above 3%, the central bank veteran said.

Policy makers have little choice but to push rates higher because they can’t afford to allow inflation expectations to escalate, ex-Fed Governor Laurence Meyer said. If that happened, the battle to contain inflation would be lost because companies and workers would begin to act in ways that would push prices ever higher.

Meyer, who heads the Monetary Policy Analytics consulting firm, foresees a downturn that reduces gross domestic product by 0.7% next year, raises unemployment to 5% and returns inflation to the Fed’s 2% target in 2024.

“A mild recession is probably pretty good from the Fed’s point of view, given the situation we’re in and how bad it looks,” he said.

Some analysts contend the US is already in a recession. GDP contracted at a 1.6% annualized pace in the first quarter and may have shrunk further in the second, at least according to the Atlanta Fed’s economy tracker. (Economists surveyed by Bloomberg forecast a rebound). 

If the Atlanta Fed estimate is borne out by official data on July 28 — the day after the Fed’s rate decision — that would meet the popular definition of a recession: two straight quarters of negative growth.

Fed policy makers have already pushed back on that narrative, pointing to the strength of the job market. “It’s really odd to think of an economy where you add 2.5 million workers and output goes down,” Fed Governor Christopher Waller said on July 7, while stressing his determination to lower inflation to 2%.

Supply Shocks

In a paper presented to a European Central Bank conference last month, researchers found that one-third of US inflation through the end of 2021 was due to supply shocks.  

The shocks “are happening in different sectors, at different times, in different countries,” one of the researchers, University of Maryland professor Sebnem Kalemli-Ozcan, said. “This is not in the central banking playbook.”

While the Fed needs to respond to elevated inflation by curbing excess demand, it should be careful not to overdo it, she said. 

Hopes for an end to supply chain snarls keep getting frustrated, especially as China struggles with its Covid Zero containment policy. Two-thirds of companies surveyed by the National Association of Manufacturers last quarter don’t expect supply chain disruptions to abate until 2023 or after.  

Blinder said he’s feeling slightly better about the possibility of an economic soft landing given recent drops in energy and food prices. But he’s unsure how durable those declines will be and still pegs the chances of a recession above 50%.  

“The odds are against the Fed managing this,” the Princeton University professor said.

©2022 Bloomberg L.P.

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IMF approves Sri Lanka’s $2.9bn bailout – Al Jazeera English

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Sri Lanka’s president has said that the International Monetary Fund (IMF) has approved its request for a $2.9bn bailout and the country’s presidency said the programme will enable it to access up to $7bn in overall funding.

The IMF’s board confirmed it has signed off on the loan, which clears the way for the release of funds and kicks off a four-year programme designed to shore up the country’s economy.

The decision will allow an immediate disbursement of about $333m, the IMF said, and will spur financial support from other partners, potentially helping Sri Lanka emerge from its worst financial crisis in decades.

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But IMF Managing Director Kristalina Georgieva warned that Colombo must continue pursuing tax reform and greater social safety nets for the poor – and rein in the corruption that has been partly blamed for the crisis.

“I express my gratitude to the IMF and our international partners for their support as we look to get the economy back on track for the long term through prudent fiscal management and our ambitious reform agenda,” Sri Lanka’s President Ranil Wickremesinghe said in a statement on Monday.

The country defaulted on its foreign debt in April 2022 as it plunged into its worst economic downturn since independence because of a major shortage of foreign currency reserves.

The Indian Ocean nation of around 22 million people ran out of cash to finance even the most essential imports, leading to widespread social unrest.

Mass protests over economic mismanagement, acute shortages of food, fuel and medicines, and runaway inflation forced President Gotabaya Rajapaksa to flee the country and resign in July.

Rajapaksa was replaced by President Wickremesinghe, who has implemented tough spending cuts and tax hikes in an attempt to secure IMF assistance.

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IMF staff had provisionally approved the bailout in September, but the final green light was held up until China, the island’s biggest bilateral lender, agreed to restructure its loans to Colombo.

Beijing had said this year that it was offering a two-year moratorium on its loans to Sri Lanka, but the concession fell short of IMF expectations for the sustainability of the island’s debt.

Wickremesinghe had said after China agreed to restructure its loans that he expected the first tranche of the IMF package would be made available within the month.

Earlier on Monday, Wickremesinghe’s office said he was seeking a 10-year moratorium on Sri Lanka’s foreign debt as the country was out of foreign reserves to service its loans.

Officials involved in the negotiations said the terms of debt restructuring must be finalised and agreed upon by all parties before June, when the IMF is expected to review the bailout programme.

Wickremesinghe’s office said in a statement that the IMF programme will help improve the country’s standing in international capital markets, making it attractive for investors and tourists.

Wickremesinghe told the country’s parliament earlier that there were signs the economy was improving, but there was still insufficient foreign currency for all imports, making the IMF deal crucial so other creditors could also start releasing funds.

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Call to tackle corruption

Colombo is also banking on the IMF deal to unfreeze billions of dollars in foreign aid for projects suspended since Sri Lanka defaulted on its loans last year.

The government has already doubled taxes, increased energy tariffs threefold and slashed subsidies in an effort to meet the preconditions of the IMF bailout.

The austerity measures have also led to strikes that halted the health and logistics sectors last week. Wickremesinghe has said he had no alternative but to go with an IMF programme.

Georgieva said Sri Lanka must stick with its controversial tax reforms, manage government expenditure and do away with energy subsidies.

In a statement, she said that “the momentum of ongoing progressive tax reforms should be maintained, and social safety nets should be strengthened and better targeted to the poor”.

She also urged Colombo to tackle endemic corruption.

“A more comprehensive anti-corruption reform agenda should be guided by the ongoing IMF governance diagnostic mission that conducts an assessment of Sri Lanka’s anti-corruption and governance framework,” she said.

Sri Lanka’s economy shrank by a record 7.8 percent last year as it grappled with its worst foreign exchange shortage since independence from Britain in 1948.

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Sri Lanka secures $3B IMF bailout to help salvage bankrupt economy – CBC.ca

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The International Monetary Fund (IMF) said Monday that its executive board has approved a nearly $3 billion US ($4.1 billion Cdn) bailout program for Sri Lanka over four years to help salvage the country’s bankrupt economy.

An IMF statement said about $333 million US ($455 million Cdn) of the funding will be disbursed immediately and the approval will also open up financial support from other institutions.

“Sri Lanka has been facing tremendous economic and social challenges with a severe recession amid high inflation, depleted reserves, an unsustainable public debt, and heightened financial sector vulnerabilities,” the IMF statement quoted managing director Kristalina Georgieva as saying.

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“Institutions and governance frameworks require deep reforms. For Sri Lanka to overcome the crisis, swift and timely implementation of the EFF-supported program with strong ownership for the reforms is critical.”

The office of Sri Lanka’s president said the IMF approval will unlock financing of up to $7 billion ($9.6 billion Cdn) from the fund and other international multilateral financial institutions.

WATCH | How Sri Lankans are coping with political, economic turmoil: 

How Sri Lankans are coping with political and economic turmoil

7 months ago

Duration 3:03

CBC’s Salimah Shivji gives an inside look at how the political and economic unrest in Sri Lanka is hurting everyday people.

Earlier this month, the last hurdle for the approval was cleared when China joined Sri Lanka’s other creditors in providing debt restructuring assurances.

“From the very start, we committed to full transparency in all our discussions with financial institutions and with our creditors,” president Ranil Wickremesinghe said in a statement from his office. “I express my gratitude to the IMF and our international partners for their support as we look to get the economy back on track for the long term through prudent fiscal management and our ambitious reform agenda.”

Wickremesinghe said he has made some tough decisions to ensure stability, debt sustainability and to grow an inclusive and internationally attractive economy.

Sri Lanka increased income taxes sharply and removed electricity and fuel subsidies, fulfilling prerequisites of the IMF program. Authorities must now discuss with Sri Lanka’s creditors on how to restructure its debt.

Protesters shout slogans and hold up signs.
People shout slogans and hold up signs during a protest against the Sri Lankan government increasing income tax in Colombo on Feb. 22. (Eranga Jayawardena/The Associated Press)

“Having obtained specific and credible financing assurances from major official bilateral creditors, it is now important for the authorities and creditors to make swift progress towards restoring debt sustainability consistent with the IMF-supported program,” Georgieva said.

“The authorities’ commitments to transparently achieve a debt resolution, consistent with the program parameters and equitable burden sharing among creditors in a timely fashion, are welcome,” she said.

Currency crisis

Sri Lanka announced last year that it is suspending repayment of its foreign debt amid a severe foreign currency crisis, because of a fall in tourism and export revenue due to the COVID-19 pandemic, mega projects funded by Chinese loans that did not generate income and releasing foreign currency reserves to hold the exchange rates for a longer period.

The currency crisis created severe shortages of some foods, fuel, medicine and cooking gas leading to angry street protests that forced then-president Gotabaya Rajapaksa to flee the country and resign.

Since Wickremesinghe took over, he has managed to reduce shortages and ended hours-long daily power cuts. The Central Bank says its reserves have improved and the black market no longer controls the foreign currency trade.

However, Wickremesinghe’ s government is likely to face hostility from trade unions over his plans to privatize state ventures as part of his reform agenda and public resentment may increase if he fails to take action against the Rajapaksa family, who people believe were responsible for the economic crisis.

Wickremesinghe’s critics accuse him of shielding the Rajapaksa family, who still control a majority of lawmakers in Parliament, in return for their support for his presidency.

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Australia Puts Policy Pause Back on the Table as Economy Slows – BNN Bloomberg

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(Bloomberg) — Australia’s central bank will consider pausing its policy tightening cycle next month given interest-rate settings are already restrictive and the economic outlook remains uncertain, minutes of its March meeting showed.

The Reserve Bank delivered its 10th consecutive rate hike two weeks ago to take the cash rate to 3.6% as board members judged inflation in Australia is “too high” and the labor market “very tight,” minutes of the March 7 meeting showed Tuesday.

Even so, the RBA board returned to the question of standing pat during its discussions.

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“Members agreed to reconsider the case for a pause at the following meeting, recognizing that pausing would allow additional time to reassess the outlook for the economy,” the minutes showed. ”At what point it will be appropriate to pause will be determined by data and the board’s assessment of the outlook.”

While the minutes are dated given the banking sector stress that has roiled financial markets across the world, they show Australian policymakers were already focused on economic uncertainties ranging from the outlook for household consumption to credit growth.

“Members noted that monetary policy was in restrictive territory and that the economic outlook was uncertain,” the minutes showed. “The outlook for consumption remained a key source of uncertainty.” Board members also discussed the “significant financial pressures” that some households are experiencing.

Overnight indexed swaps have swung significantly since the banking crisis in the US and Europe and now imply the RBA will stand pat at its April 4 meeting and then begin cutting in August. Money markets now signal that the global monetary tightening cycle is all but done.

All eyes will be on a number of major central bank meetings over the coming days, led by the Federal Reserve with its decision likely to influence the RBA’s call next month.

Assistant Governor Chris Kent this week sought to alleviate concerns the banking crisis will become systemic, maintaining Australian lenders are “unquestionably strong” with solid balance sheets and capital positions.

Australia has lagged international peers in the scale of its rate increases, reflecting Governor Philip Lowe’s efforts to bring the economy in for a soft landing. The minutes showed the RBA’s tightening bias remained intact however, with a monthly inflation indicator and retail sales data – due next week – gaining extra prominence.

The RBA’s rapid-fire rate hikes have created a political problem for Prime Minister Anthony Albanese as he tries to persuade a heavily indebted electorate grappling with rising living costs that the pain of increased borrowing costs is preferable to entrenched inflation.

The government will release its budget in May, which is likely to have some targeted cost relief measures, although Treasurer Jim Chalmers has said it will keep a tight leash on fiscal spending to avoid further fueling consumer prices.

©2023 Bloomberg L.P.

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