Stay updated with our complimentary newsletter
Subscribe to the Global inflation myFT Digest for the latest updates delivered straight to your email inbox.
Central banks are being cautioned by the Bank for International Settlements against premature interest rate cuts due to the potential resurgence of inflation, as policymakers worldwide consider the pace at which to ease monetary policy.
In its annual report, the Basel-based organization overseeing central banks stated that the global economy appears to be heading for a “soft landing” as inflation moderates and growth remains robust.
However, it advised policymakers to exercise caution in easing policy, emphasizing the risk of a return of inflationary pressures in areas such as services prices and wage growth, as well as the importance of maintaining flexibility to reduce borrowing costs in case of a sudden economic downturn.
The BIS also highlighted vulnerabilities in the financial system, particularly related to high levels of public debt and declining commercial property prices.
According to the BIS, premature easing could lead to a resurgence of inflationary pressures, necessitating a costly policy reversal that could undermine credibility.
In 2021 and 2022, the US Federal Reserve and the European Central Bank faced criticism for their delayed response as supply chain disruptions and energy price spikes contributed to the largest inflation surge in decades.
BIS General Manager Agustín Carstens praised the eventual “forceful tightening,” asserting that it bolstered central banks’ credibility and preempted a shift to a “high-inflation regime.”
Despite some central banks already beginning to ease policy, the BIS warned officials to remain vigilant for the return of inflationary pressures. The ECB initiated rate cuts in June, while the Fed is expected to follow suit in September.
While inflation has been gradually declining, it remains above central bank targets in many regions, including the US and Eurozone.
Carstens likened a central banker combating inflation with high interest rates to a doctor administering antibiotics to a patient with an infection, emphasizing the importance of completing the entire treatment to prevent a relapse of inflation.
The BIS identified several potential pressure points that could disrupt the soft landing, including weak public finances, low productivity growth, and persistent inflationary forces.
It warned that a rapid reversion in relative prices of goods and services or real wages could create significant inflationary pressures.
The BIS also emphasized the need for tight fiscal policy to avoid exacerbating inflationary pressures.
While the BIS noted downward pressure on inflation in some areas, it highlighted rising public debt as the primary threat to monetary and financial stability.
The organization cautioned that financial stress typically occurs two to three years after the start of a rate-rising cycle, indicating a potential risk within the next year.
Commercial property was identified as a high-risk area due to cyclical and structural challenges, with a sharp correction in property values potentially impacting lending and GDP.
The BIS also raised concerns about an “extend and pretend” strategy in commercial property, where valuations are artificially maintained to avoid losses, risking a broader financial downturn.