Global central banks push rates higher as reality bites
Barely a week after the Federal Reserve took a break from its campaign of interest rate increases, four of its counterparts overseas elected to push their policy interest rates higher Thursday.
Driving the news: The Bank of England's surprise decision to raise interest rates by half a percentage point — sent shudders through financial markets.
- Norway's central bank hiked rates by half a percentage point as well, the Swiss National Bank went with a quarter point increase and the Turkish central bank announced a whopping 6.5 percentage point rise.
Why it matters: Their actions — and particularly those in Britain and Turkey — show something important about the global economy in this era of elevated inflation. Cold hard facts about the economy beat wishful thinking.
- There have been currents of optimism that inflation can be brought down without much economic pain. It might be happening in the United States (emphasis on might), but the global trend is less clear.
- U.S. inflation appears to be fading, giving the Fed the flexibility to take a breather from its rate-rising campaign. By contrast, Britain's core inflation surged to 7.1% in the year ended in May — the highest since 1992 and up from 6.8% in April.
State of play: The British economy is still adjusting to its post-Brexit reality, in which it is less integrated with the European Union and thus more economically isolated. Combined with the ongoing energy supply disruptions due to Russia's invasion of Ukraine, that has effectively made the nation poorer.
- The continued high inflation there reflects households and the government not adapting their spending to that reality.
- With its more aggressive interest rate hikes, the BoE is attempting to bring demand into balance with that underlying reality. But it could be painful for British citizens and businesses.
What they're saying: "A fast train of realisation is set to hit that budgets are set for a big squeeze," said Susannah Streeter, head of money and markets at Hargreaves Lansdown, in a note.
- "With borrowing costs shooting up again and many more companies and consumers set to tighten belts, the prospects of the UK avoiding a recession look very slim," she said.
The big picture: An even more vivid tale of economic reality coming to roost is underway in Turkey, which has pursued an upside-down strategy embraced by President Recep Tayyip Erdoğan of fighting inflation with interest rate cuts.
- That changed Thursday, marking a huge step in the country's approach to dealing with 40% inflation. Turkey's central bank raised its key rate by 6.5 percentage points to 15%. Remarkably, that was actually a smaller rate hike than markets expected.
The move is the first under the country's new top central banker, Hafize Gaye Erkan, a longtime Wall Street executive who is expected to push Turkey into an era of more conventional monetary policy.
- It comes after a long stretch of a very non-traditional approach from Erdoğan, who embraced low rates as a solution to the inflation surge.
- That exacerbated capital flight out of the country. There have been devastating implications for the economy.
Where it stands: Turkish inflation, while still very high, is down from its peak of 85% last fall.
- The lesson for the U.S. is that forecasts and projections aren't what really matter for the outlook for rates and markets. It's the facts on the ground of whether inflation — still trending at around a 5% rate — really does diminish further, absent another wave of tightening from the Fed.
The bottom line: Policymakers have to accept the world as it is, not as they wish it to be.