WASHINGTON (Reuters) – Central banks should not halt their fight against inflation because of financial stability risks, which look “very much contained,” International Monetary Fund chief economist Pierre-Olivier Gourinchas told Reuters.
The IMF built expectations of more persistent inflation and further tightening into its latest economic forecasts released on Tuesday compared to its outlook in January, Gourinchas told Reuters in an interview. The IMF also factored in a slight pullback in bank lending after banking sector turmoil in March, he added.
The IMF’s World Economic Outlook shows a 0.1 percentage point markdown in global growth to 2.8% for 2023, partly because of these factors, along with slowdowns in Europe, Japan and India, offset by improvements in the United States.
Gourinchas said most large central banks, including the Federal Reserve, the European Central Bank and the Bank of England, are already near the peak of their rate hike cycles.
“From that vantage point they may need to do a little bit more if inflation proves a little bit more persistent,” he said, but a pullback in lending by banks after recent financial turmoil seems likely and that may “do the job for the central banks” by cooling the economy without the need for more aggressive rate hikes.
But asked whether continued rate hikes were creating bigger stability risks in extending the maturity and interest rate mismatches between assets and liabilities, Gourinchas came down firmly on the side of keeping up the inflation fight.
“Is it causing potentially catastrophic financial instability further down the road and as a result, should they sort of refrain from doing this?” he asked. “Our assessment on this is no, because the financial instability looks very much contained.”
Adjusting monetary policy now based on stability risks “means that we’re not doing enough on the inflation front and that is creating a problem of its own,” Gourinchas said.
SEPARATE TRACKS
Instead, authorities should contain stability risks with tools used after the failures of Silicon Valley Bank and Signature Bank, such as central bank lending facilities and other backstops, which would free up monetary policy to stay focused on bringing inflation down.
“There is the monetary policy path, and then there’s the financial stability and these two can be thought of separately, and I think that remains the right policy combination at this point,” he said.
He said that barring shocks, Fed and the ECB are “very near the top of the hiking cycle” but market participants widely betting on a quick shift back to easing rates are likely to be disappointed.
“And in my sense, if they’re expecting that because they think the Fed or central banks should take into consideration financial stability arguments…we’re not there,” Gourinchas said.
This could lead to an adjustment of yields on longer-term securities upwards as market expectations become more “realigned with what the central banks are communicating.” he added.
WHAT SLOWDOWN?
Gourinchas said the U.S. economy has proven surprisingly resilient and there is little evidence that the Fed has tightened too much, especially after strong March U.S. jobs data on Friday pushed the unemployment rate down to a historically low 3.5%.
Some softening of the job market “should be happening” and is assumed in the IMF’s 2023 U.S. growth forecast of 1.6%, he said.
“Too much would be if we started slowing the economy very rapidly and unemployment was rising very fast, but we really are not there at this point,” he said.
(Reporting by David Lawder; Editing by Chizu Nomiyama)
