Central banks must continue hiking interest rates, the International Monetary Fund (IMF) has said, and companies and shareholders must allow their profit margins to decline in order to allow inflation to ease.
The IMF’s deputy managing director, Gita Gopinath, said inflation is “taking too long to get back to target” and in the future is likely to remain more difficult to tame than before the pandemic.
So far the Bank of England has hiked rates 13 times in a row, to 5.0% from just over zero; the US Federal Reserve has hiked to 5.25% and paused, but with Fed chair Jerome Powell last week telling Congress he expects more rates rises “will be appropriate” by the end of the year; and the European Central Bank has lifted rates to 3.5% and president Christine Lagarde has said: “We are not thinking about pausing.”
Gopinath, who was speaking at a European Central Bank forum in Sintra, Portugal, said persistence of inflation “means that central banks, including the ECB, must remain committed to fighting inflation despite risks of weaker economic growth”.
This was one of three “uncomfortable truths” which, she said, central banks need to contend with.
The second was that “financial stresses could generate tensions between central banks’ price and financial stability objectives”, in other words raising interest rates will be painful and may result in recessions.
“The third uncomfortable truth is that going forward, central banks are likely to experience more upside inflation risks than before the pandemic,” she added, suggesting that the ECB, Bank of England, Federal Reserves and other central banks needed to “refine” monetary policy and what tools they use.
Inflation’s stickiness has been partially down to a combination of tight labour markets and households' solid levels of savings, so even with the tightening of interest rates, “financial conditions may not be tight enough”.
“What is worrisome is that sustained high inflation could change inflation dynamics and make the task of bringing inflation down more difficult,” she noted.
As inflation has consistently outgrown wage growth since the pandemic, leading to a “massive” decline in real wages, she said some further wage catchup is to be expected.
“All else equal, if inflation is to fall quickly, firms must allow their profit margins—which have shot up during the past two years—to decline and absorb some of the expected rise in labor costs.
“But firms may resist this, especially if the economy remains resilient, while workers may demand payback for their real wage losses. Such dynamics would slow inflation reduction and likely feed into expectations and increase susceptibility to further upside cost or resource pressures," the IMF deputy managing director concluded.