Inflation has eased globally in recent months, yet the world’s major central banks warn that the hardest phase lies ahead. “The main political challenge today is to fully control inflation, and the last mile is usually the toughest,” comments Augustine Carstens, CEO of the Bank for International Settlements, during the BIS annual report presentation in Basel.
The Bank for International Settlements cautions that “interest rates may need to stay elevated longer than the public and investors expect”
“The last mile may prove harder,” notes the BIS report covering central banks from around the world. Seventy-three institutions are included in the analysis. The tension between fees and earnings, along with runoff effects, could keep inflation elevated for a longer period. BIS adds that once inflation psychology takes hold, it is difficult to reverse it.
“Fiscal and monetary support during Covid was substantial, broad-based, and long-lasting”
“Critical and Dangerous Crossroads”
With inflation persisting, the BIS argues that “high rates may need to remain for longer” to meet public and investor expectations. This stance places the global economy at a critical juncture. The BIS highlights that rapid, sustained rate increases combine with historically high debt levels faced by many nations, creating a precarious global macro picture.
Inflation, high interest rates, and mounting debt have become an alarm bell for the financial system, echoing past stress periods and the strain on borrowers and lenders alike.
The BIS stresses that policymakers must stay the course to contain inflation and protect consumer purchasing power. It underlines that fiscal prudence and precautionary financial regulation are essential to prevent policy missteps from derailing the economy. The longer inflation endures, the greater the risk of it becoming entrenched and the higher the eventual cost of suppression. BIS simulations illustrate how a sustained inflation path and elevated rates could depress GDP in the mid-to-late 2020s, underscoring the potential gravity for major economies.
The growth illusion under scrutiny
Looking back, the BIS identifies tensions that arose from decades of treating monetary and fiscal policy as the primary engines of growth. The organization cautions against what it calls an “illusion of growth,” where exceptionally low interest rates encouraged heavier public and private debt without guaranteeing durable economic resilience.
During periods of historically low rates, governments’ spending responses to the Covid shock and subsequent inflationary pressures were expansive. In hindsight, the BIS notes that it was a broad-based and long-running support. As policies evolve, the BIS warns against repeating the same trap, where debt-led growth masks underlying fragility and undermines sustainable progress.
The BIS also points to the broader responsibilities of central banks, who act as the central banks to the world’s financial systems. The discussion highlights the importance of stabilizing policy and maintaining confidence, especially after episodes of regional banking stress in the United States and the turbulence surrounding Credit Suisse. These developments underscore the BIS’s emphasis on robust banking supervision and coordinated international safeguards.
Historical experience shows that bank tensions often follow tighter monetary policy. In many cases, the first rate hikes occurred in the early 2020s as part of efforts to address inflation, reinforcing the need for prudent policy sequencing and vigilance over financial stability.
Hidden risks of a financial crisis
The BIS flags the possibility of financial stress if rate increases slow credit growth and when debt burdens remain high or asset prices weaken. The organization notes that its 1930 founding continues to shape a cautious, forward-looking view of financial stability.
The test will come as rate rises begin to translate into credit losses. The BIS anticipates losses roughly in line with historical averages, but warns that a prolonged, higher-rate environment could push losses toward the upper end of historical ranges. Strengthening the capitalization of banking systems is seen as a key mitigant against widespread damage.
In the face of potential deposit outflows, the BIS advises careful use of deposit guarantees and a balanced market discipline approach. Proposals that erode bank resilience or weaken safeguards risk broad financial instability and should be approached with caution.