Central banks must stay on inflation alert in era of volatility, BIS says

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Conflicts, climate change and trade tensions mean central banks will need to raise interest rates “more forcefully” during future bouts of inflation to prevent price pressures taking hold, a senior official at the Bank for International Settlements has said.

Andréa Maechler, deputy general manager at the Basel-based umbrella body for central banks, said monetary policymakers could no longer afford to “look through” short-term price spikes caused by disruption to the supply side of the economy — such as crop failures, blockages in ports, swings in commodity prices or shutdowns at oil refineries.

Such shocks could become “larger and more frequent” because of rising geopolitical risk, more widespread floods and droughts and a “bumpy transition” to greener technologies, she said.

“This may require adjustments to the conduct of monetary policy,” Maechler said. “At times, forceful monetary tightening will be needed to ensure that inflation expectations remain anchored.”

Her comments, at an event on Wednesday in London, came as the worsening conflict in the Middle East pushed up oil prices and economists warned strikes by US dockworkers could inflate goods prices if their actions lasted longer than a week.

She said ageing populations and rising barriers to globalisation would make it harder for economies to adjust to this kind of disruption, as labour shortages became more widespread and there was less scope “for international trade to act as a shock absorber of domestic inflationary pressures”.

Maechler highlighted trends observed after the coronavirus pandemic, arguing that once inflation had begun to rise, a further shock to oil or food prices can have an “outsize influence” on people’s trust in the stability of money. That response can lead to sudden changes in behaviour of households and businesses that leads to inflation becoming entrenched.

“All this means that inflation could become more volatile, raising the risk that economies transition more easily from self-stabilising low-inflation regimes to self-reinforcing high-inflation regimes,” she said.

The BIS has long been a hawkish voice, warning central banks as early as 2010 of the dangers of adopting ultra-low interest rates for too long, a warning delivered shortly before the eurozone debt crisis forced the European Central Bank to cut rates further into negative territory for the best part of a decade.

But its views have gained currency over the past few years as central banks raised interest rates to their highest levels since the global financial crisis to tame inflation.

Prices surged in 2022 on the back of pent-up demand after Covid-19, global supply chain disruptions and higher energy prices caused by Russia’s invasion of Ukraine.

Although the US Federal Reserve, ECB and Bank of England are increasingly confident inflation is subsiding, potentially enabling them to continue cutting rates in the coming months, policymakers have signalled they do not expect interest rates to return to pre-pandemic lows.