If Bank of England chief economist Hugh Pill were so inclined, Cape Town’s iconic mountain would be a model for monetary policy. In this model, after a relatively steep climb, there is a long period of stabilization before the descent. This is in contrast to the famous Swiss mountain, which reaches a steep summit and then begins a rapid descent.
According to the Financial Times, Piru used this analogy at a conference in South Africa in late August. Recently, Pill’s monetary ‘Table Mountain’ has started to materialize. For the first time since late 2021, the Bank of England has not raised interest rates. At the same time, the central bank has announced that it will maintain a ‘sufficiently restrictive’ policy to combat inflation, suggesting that a rate cut is not on the horizon.
While significant or further rate hikes are not necessary to effectively fight inflation, there seems to be a consensus among central banks around the world that interest rates should remain elevated for an extended period, at least for most of 2024.
Last week, the Federal Reserve, the US Federal Reserve and the Swiss National Bank opted to leave interest rates unchanged. However, Fed officials have suggested that additional rate hikes could come later this year and high interest rates could persist. This scenario spooked investors on Thursday and sent US stock prices lower, but they recovered on Friday.
The previous week, the European Central Bank raised interest rates, signaling that this could be the last rate hike. In any case, the ECB emphasized the importance of maintaining high interest rates “for a sufficiently long period”.
High interest rates are the central bank’s main tool in the fight against inflation. High interest rates make borrowing less attractive for both individuals and businesses, discouraging spending and investment and ultimately limiting price growth.
Despite central banks’ inflation target of 2%, actual inflation has been above this threshold, at 6.7% in the UK, 5.2% in the euro area and 3.7% in the US. However, central bank rate hikes usually take one to two years to have an impact on inflation. Given that interest rate hikes have been ongoing for about 18 months and inflation has been on a downward trend for several months, the possibility of a plateau in interest rates has emerged.
Interest rates that were just above or below zero in the immediate aftermath of the UK/US pandemic are now at 5.25-5.5% (US), 5.25% (UK) and 4% (Eurozone). The ECB, FRB and Bank of England have indicated their intention to maintain current interest rates for the time being, thus allowing 2% before considering any policy easing. aims to emphasize the importance of actually achieving the 2% inflation target.
However, it remains unclear whether the Table Mountain analogy accurately reflects the situation. The trajectory of interest rates could become unpredictable. If inflation rises sharply again, the possibility of raising interest rates remains. Central banks remain cautious about both the size and duration of the post-pandemic inflation pick-up. The lesson here is to keep all options open.
It is possible that interest rates could fall again next year, especially if the economy enters a severe recession. Financial markets are abuzz with speculation about this scenario, especially as the Eurozone and UK economies are showing signs of weakening. A survey of corporate purchasing managers on Friday showed a decline in economic activity.
Part of this economic slowdown is due to the impact of interest rate hikes. As a recent study by the International Monetary Fund (IMF) showed, inflation controls often cause short-term economic pain. The IMF’s conclusion, however, is that in the long run, price stability is favourable for the economy. The IMF’s message to central banks today is that persistence in the fight against inflation is key and that those who ‘celebrate victory too soon’ may be defeated.