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Calls for global central banks to be mindful

Tan KW
Publish date: Mon, 27 Mar 2023, 09:58 AM
Tan KW
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SINGAPORE: Key central banks are probably losing control over the economic fallout amid their unwavering commitment to fight stubbornly high inflation with large interest rate hikes.

If history is any guide, aggressive rounds of rate hikes - or monetary policy tightening, as it is known - usually do not result in an orderly economic slowdown with slower growth purging inflation without causing a recession.

Add to this the lingering crisis of confidence following bank failures in the United States and the collapse of one of Europe’s biggest financial institutions, and it is clear why many analysts believe the risk of a downturn has risen considerably.

The recent rate hikes by the European Central Bank, the US Federal Reserve and the Bank of England were an attempt to shore up confidence in their ability to manage inflation and financial stability - both integral to their mandates.

But if another bank blows up in the coming days, their rate decisions will be seen as acts of bravado, putting their credibility at risk.

For instance, US regional lender First Republic Bank received another credit ratings downgrade as Fitch Ratings followed its peer S&P Global.

Moody’s has already placed the troubled bank on review for a possible downgrade.

The bank’s shares have lost nearly 90% of their value since March 8.

“Recent market volatility highlights the peril of a loss of market confidence,” said Madhur Jha, head of thematic research at Standard Chartered Bank, referring to the global sell-off last week sparked by the failure of Silicon Valley Bank.

Macroprudential measures such as emergency funding lines and extended deposit guarantees may have eased market concerns around the banking crisis for now. But as central banks become more proactive, banks in general and smaller ones in particular will tighten lending standards, which may lead to a credit crunch.

“Lending standards in the United States and eurozone are already close to levels historically seen in recessions,” Jha noted.

Worldwide, more scrutiny of the quality of bank loans and tighter lending conditions for the less credit-worthy will disproportionately hit small and medium-sized enterprises, which account for 90% of businesses and 50% of employment globally.

Taimur Baig, chief economist at DBS Bank, said the financial concerns evident now have ramifications beyond the banking sector’s stability.

“The sharp increase in global interest rates over the past year ought to be a source of stress in some pockets of the global economy and markets,” he said.

Many corporations have enjoyed large profits in recent years, and these have gone into building strong cash buffers or paying down debt.

“But these mitigating factors are present in some, not all, cases,” noted Baig, pointing out negative implications from higher rates for the property sector, for instance, which thrives on leverage.

Nathan Sheets, global chief economist at Citigroup, said the risks to economic growth have clearly become more acute.

Meanwhile, banking stresses may yet prove more severe or long-lived than generally expected.

The environment poses significant challenges for central banks, as inflation pressures remain severe, requiring tighter policy.

On the other hand, higher interest rates are putting stress on some segments of the financial system.

“Central banks need to be mindful that their actions are not inadvertently unleashing intensified pressures,” said Sheets.

He said that while the challenges at this stage appear manageable, the probabilities around worse outcomes are material and have risen in recent weeks.

“Experience has shown that financial stability stresses are powerful and often unpredictable,” he noted.

“Moreover, these banking-system wobbles are hitting the global economy during a period of already soft performance,” he added, referring to the outlook of weaker economic growth in 2023 compared with 2022.

Asia’s export-driven economies, including Singapore, are already suffering significant contraction in demand for their goods. And even though banks and the bond market in the region have generally shown resilience to the tumult in the United States and Europe, some analysts have warned that they cannot remain completely insulated from a global shift in market sentiment.

Alicia Garcia Herrero, chief Asia-Pacific economist at French investment bank Natixis, said: “There is no reason to believe that the acute risk-off environment will not reach Asian financial institutions or hit high-yield issuers harder in the future if risk sentiment stays cautious.”

The only upshot from a hard landing scenario, which will inflict more pain on the global economy, is the accelerated disinflation it may bring in its wake.

 - ANN

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