26 September 2023

Interest rates by 1 percentage point in Canada: Could Australia follow?

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Elysse Morgan* says the world’s central banks ‘have egg on their face’ and risk causing a recession in their ‘panic’ to get it off.

The Bank of Canada’s (BoC) shock decision to raise interest rates by 1 percentage point has taken global markets and Canadian borrowers by surprise and ramped up expectations more central banks will follow with super-sized hikes.

The BoC lifted its policy rate from 1.5 per cent to 2.5 per cent, the highest it has been since 2008, in a bid to arrest inflation.

It is far from alone in rapidly raising interest rates.

On Thursday, the Philippines central bank raised rates by 0.75 of a percentage point to 3.25 per cent in an unscheduled move, while Singapore’s authorities also tightened monetary policy in a surprise move this morning.

On Wednesday it was the Bank of Korea and Reserve Bank of New Zealand both raising rates by half a percentage point, in the latter’s case for the third meeting in a row.

The aggressive but uncoordinated action by central banks worries former IMF chief economist Maurice Obstfeld, who says there is a real risk that they take rates too high while trying to fight inflation.

“You’ve got a real cocktail of global monetary contraction that could go a bit too far because each central bank is looking only at its own domestic situation and not thinking about the global effects,” he warned.

Canada was the first G7 country to make such an aggressive rate hike in this economic cycle, but bets are rising that the US Federal Reserve will follow after inflation came in much higher than anticipated, at 9.1 per cent for the year to June.

A member of the Federal Reserve’s rate-setting committee, Raphael Bostic, further stoked fears of more super-sized rate hikes from the Fed by saying “everything is in play” for the meeting later this month.

An unexpectedly big fall in Australia’s unemployment rate to 3.5 per cent means a local 75-basis-point rise now “can’t be ruled out” when the RBA meets again next month, according to AMP Capital’s Shane Oliver, while it is Deutsche Bank’s baseline forecast.

The Bank of England has so far only raised rates by 25-basis-point increments to a 13-year high of 1.25 per cent, but has said it is ready to act “forcefully” to stamp out inflation that is heading north of 11 per cent.

Central banks risk a re-run of the 1980s

These moves have heightened concerns that central banks risk expediting the global economy’s path into a deep recession by not co-ordinating their hikes.

“We saw something like that in the early 1980s when the Fed was fighting inflation hard,” Professor Obstfeld, who teaches economics at the University of California Berkeley, told the ABC’s The Business program.

“The dollar appreciated to stratospheric heights [and] depreciations that US trade partners experienced hampered their efforts to disinflation, so they raised interest rates probably more than they would have otherwise.

“And so we got a very deep global recession which spilled over to emerging markets in the form of the debt crisis of the 1980s and I think there is a risk of something similar now.”

He believes central banks waited too long to lift interest rates and are now panicking, trying to catch up.

“They have egg on their face from having been behind the curve, and there is a little bit of a sense of panic in the air,” he said.

“A great example is your RBA: two back-to-back 50-basis-point increases when inflation is between 5 and 6 per cent.

“Now, governor [Philip] Lowe is predicting that inflation, notwithstanding those rate increases, will reach the 7 per cent level.

“[Federal Reserve chair] Jay Powell would be very happy to have 7 per cent at this point.”

Professor Obstfeld, a former economic adviser to then US president Barack Obama who has contributed to a key economic paper prepared ahead of this year’s G20 meeting in Indonesia, believes that super-sized rate hikes in the West will really hurt developing and emerging economies.

“They ran up higher debts to deal with COVID, and facing higher interest rates will put greater fiscal pressures on them,” he warned.

“The many poor households can’t really deal with the energy and food prices we’re seeing without some sort of government support, which will be a further strain on budgets.”

He believes the global community needs to think hard and act on reforms that might make debt restructuring for poorer countries more orderly and less traumatic.

“If you’re in the UK, and you know that Europe is tightening and the US is tightening, and Canada and Australia are tightening, and the range of developing economies are tightening, you sort of say, well you could go a little easier because the spillover effects are going to be powerful, and maybe we shouldn’t go that far.”

*Elysse Morgan is an ABC business and finance reporter. She is presenter of The Business on ABC TV and ABC NEWS Channel.

This article first appeared at abc.net.au.

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