The case for rate hikes heading for contested territory as recession looms

The inflation battle is the most desirable real estate in global monetary policy. Most titans of central banking are emphatic that rapid price increases are the scourge of the moment, going so far as to countenance recession as an acceptable price to pay for victory. A parade of Federal Reserve officials in recent days has sought to emphasize this message — though a slump isn’t their forecast.  
 

Could this dominant line have some serious competition? The stated willingness to tolerate a downturn, if not outright engineer one, hasn’t really been tested. The time for that might not be too far away. Brazil is having doubts about the wisdom of many more hikes after 12 consecutive increases. A respected think tank in London says the UK economy is already in recession. In South Korea, India, Malaysia and Thailand, traders are betting growth concerns will crowd out inflation angst, even if that hasn’t been reflected in official remarks.

At least one authority might be starting, ever so gently, to hedge after a late start to tightening followed by rapid-fire interest-rate hikes. Along with a requisite commitment to bring inflation under control, the Reserve Bank of Australia this week flagged the importance of “keeping the economy on an even keel.” The new language accompanied a worrisome reduction in growth forecasts and an uptick in inflation estimates.

The RBA, which nudged up its benchmark rate by half a percentage point Tuesday, isn’t done withdrawing accommodation. Borrowing costs are still below the bank’s estimate of neutral, a hard-to-pinpoint zone where settings neither aid nor brake the economy. But the wording looks designed to push back against the idea that Governor Philip Lowe will blithely allow the expansion to die. “Taming inflation might not be the RBA’s only focus,” Andrew Ticehurst, a strategist at Nomura, wrote in a note.

The path, the bank conceded, is a narrow one. The wording isn’t exactly a bombshell at home or away — policy makers have said much the same verbally from time to time — but including it in the statement elevates its stature. Every word in central banking communiques is labored over, including those that are omitted.

Stand by for a few more qualifiers in the struggle against inflation.

New Zealand is a good place to watch. The Reserve Bank of New Zealand went early and went hard, pushing rates higher while the Fed, RBA, Bank of England and the European Central Bank were wringing their hands over ending quantitative easing. Now, unemployment is starting to creep up, albeit in tandem with climbing wages. Kiwi home prices are declining and confidence among companies and consumers is waning. That’s not to say the RBNZ will balk at a fourth 50-basis-point increase this month, but it does warrant a discussion that’s less lopsided. The bank is likely to cut rates in 2023, a year earlier than its own projections will allow, according to Capital Economics. The firm thinks the RBA will go the same route.

The housing market in South Korea, one of the world’s frothiest during the easy-money era of the pandemic, also looks fragile. The industry faces a deep correction as rates climb, says a Bank of Korea study released this week. That’s to be expected; the central bank had long worried about an overheating property market. It also underscores that the tightening campaign isn’t without cost. July’s 50-basis-point step might be a one-time thing. 

A certain amount of prudence will naturally enter the rate dialogue as more central banks move to neutral. The race to outdo each other with ever more sizeable hikes will soon subside. That’s not the same as saying their work is done; nobody has walked away from the case for higher rates. Increments will become more modest. Dovish pivot? Not exactly. Just listen to Neel Kashkari, long characterized as the uber-dove of the Federal Open Market Committee, who said Wednesday he’s “laser-focused” on inflation.

It wasn’t all that long ago that Lowe was shaping up to be the only governor in the RBA’s six-decade history not to raise interest rates. That was when hikes appeared years away; the bank at one point projected 2024 as the year for liftoff. Policy can change, and quickly, too. Hikes are the flavor of 2022. The terrain will be more contested next year, especially if faltering activity is able to make inflation less odorous.