“Global inflation…”

Inflation continues to be the main focus in the market updates.

World Bank warns higher rates risk causing global recession

The World Bank has warned that leading central banks risk sending the global economy into a “devastating” recession next year if policymakers raise interest rates too high over the months ahead and stress financial markets. Energy and food prices have surged following Russia’s invasion of Ukraine in late February, triggering a cost of living crisis. To avoid letting inflation rip, the World Bank urged governments to provide targeted relief to vulnerable households instead of relying on tighter monetary policy. The World Bank did not produce new forecasts for the global economy, but noted that the outlook for 2023 had been sliding as rich and poor countries alike responded to high inflation this year by seeking to limit spending. “Central banks around the world have been raising interest rates this year with a degree of synchronicity not seen over the past five decades — a trend that is likely to continue well into next year,” the World Bank said.  The expected rises in global interest rates would bear down on inflation, but not enough to meet central banks’ targets, which are usually around 2 per cent, the World Bank warned. Core global inflation, excluding energy, was still likely to be running at a rate of 5 per cent next year, twice the pre-coronavirus pandemic rate. If such a level of inflation persuaded central banks to become even more aggressive, global economic growth would drop to 0.5 per cent in 2023, according to the World Bank.

Eurozone Business Activity

Banque de France Governor François Villeroy de Galhau said the European Central Bank could raise interest rates to almost 2% by the end of the year. Monetary policy normalization is “fully justified,” Villeroy de Galhau said at the Michel Camdessus Central Banking Lecture at IMF headquarters in Washington, DC on September 14. Eurozone inflation rose by 9.1% year-on-year in August, a record high. On September 8, the Governing Council of the ECB raised interest rates by 75%.

While headline inflation reached 9.1 percent in August and is expected to rise further, most indicators of long-term inflation expectations are still hovering around the ECB’s 2 percent target. However, recent revisions of some indicators above the target have raised concerns among policymakers, who have pledged to monitor developments closely. The ECB has faced criticism for reacting too slowly to rising prices. ECB Vice President De Guindos warned that the central bank must not compromise its credibility.

How Italy could tip into a tailspin

Next month it will be 100 years since Benito Mussolini launched his fascist coup in Italy when his supporters marched on Rome. Later this month the country is almost certain to elect Giorgia Meloni, a former post-fascist and eurosceptic as its new prime minister. So far, investors haven’t blinked. Meloni is the favourite to replace Mario Draghi, the highly respected technocrat who helped save the euro a decade ago. Yet the gap between yields on Italian and German 10-year government bonds is 2.3 percentage points, the same level as when “Super Mario’s” government started to collapse in July.

Italy will probably muddle through under Meloni, the leader of the Brothers of Italy, which opinion polls suggest will be the largest party after this Sunday’s election. But there’s also a medium-term risk that the country’s massive debt will spin out of control. This could happen under her watch or, given the short life of most Italian governments, under a different prime minister.

Meloni’s right-wing alliance is promising lower taxes and early retirement. Yet investors are calm because she has abandoned her euroscepticism and says tax cuts depend on the state of the country’s finances, which she promises will be safe in her hands.

Italy’s next prime minister will want to avoid the fate of previous governments which picked fights with the European Union over fiscal policy. Silvio Berlusconi was ejected from power in 2011 after yields on 10-year government bonds shot up to 4.9 percentage points above Germany’s. The anti-austerity coalition led by Giuseppe Conte, which collapsed in 2019, faced a similar experience.

Investors are also relaxed because the EU is showing more solidarity than during the euro crisis a decade ago. In response to the Covid-19 pandemic, it launched a Recovery and Resilience Facility made up of cheap loans and grants. Italy will receive the biggest chunk: 192 billion euros, equivalent to nearly 10% of national income.

The EU has also suspended fiscal rules which require member countries to keep budget deficits below 3% of GDP – a suspension that may be extended as a result of the current energy crisis. As a result, Meloni will not have to cut spending or raise taxes immediately.

Russia’s invasion of Ukraine has also strengthened EU solidarity. Meloni’s consistent criticism of Vladimir Putin has won her brownie points in parts of the EU, even though many disagree with her views on LGBTQ rights and immigration.

The European Central Bank also has a new tool to stop the euro zone fragmenting. It will buy the bonds of governments that come under speculative attack so long as their debt is sustainable. Nobody wants Italy to go into a tailspin and drag down countries such as France and Spain, which also have high levels of sovereign debt.

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