Why major central banks should raise rates now

Major central banks should press ahead with interest rate increases, the Bank for International Settlements says, while recognising that some turbulence in markets will have to be negotiated along the way.

The bank, an umbrella body for leading central banks, said on Sunday in one of its most upbeat annual reports for years that global growth could soon be back at long-term average levels after a sharp improvement in sentiment over the past year.

Though pockets of risk remained because of high debt levels, low productivity growth and dwindling policy firepower, the bank said policy makers should take advantage of the improving economic outlook and its surprisingly negligible effect on inflation to accelerate the “great unwinding” of quantitative easing programmes and record low interest rates.

New technologies and working practices were probably helping to suppress inflation, it said, though normal impulses should kick in if unemployment continued to drop.

“Since we are now emerging from a very long period of very accommodative monetary policy, whatever we do, we will have to do it in a very careful way,” said the bank’s head of research, Hyun Song Shin.

Stay the Course

“If we leave it too late, it is going to be much more difficult to accomplish that unwinding. Even if there are some short-term bumps in the road it would be much more advisable to stay the course and begin that process of normalisation.”

Good communication from central bankers will would be important, but even more crucial is was the need for banks to be strong enough to cope with any turbulence.

The Bank for International Settlements identified four main risks to the global outlook in the medium term: a sudden flare-up of inflation that forces up interest rates and hurts growth; financial stress linked to the contraction phase of financial cycles; a rise in protectionism; and weaker consumption not offset by stronger investment.

The first seems unlikely for now, with Shin saying the bank had been surprised that inflation and wage growth had remained so subdued as growth in major economies picked up.

The question for central bankers was whether new technologies and working practices had fundamentally changed the inputs in their economic models and whether it was right to keep such a heavy focus on keeping inflation at certain levels.

But inflation was not the only variable. “We should keep one eye at least on financial developments,” Shin said.