What happened
The global inflation surge of 2021-22 was induced by fiscally stimulated demand and constrained supply conditions in the post-pandemic period, along with the effects of the war in Ukraine on commodity and food prices.
Central banks reacted to high inflation by implementing the fastest monetary policy tightening cycle in decades, pushing up short- and long-term borrowing costs.9
What’s next
With inflation falling quickly and generally moving back toward central banks’ inflation targets, the tightening cycle appears largely over. Some emerging markets have already begun cutting rates and more policymakers in emerging and advanced economies are considering carefully easing monetary policy.10
But upside risks to inflation from still-elevated wage growth, potential supply shocks and geopolitical risks – including the recent increase in shipping costs – will translate into a gradual easing cycle with interest rates expected to remain well above pre-pandemic levels.
The US Federal Reserve11, European Central Bank12, Bank of England13, Reserve Bank of Australia14, South African Reserve Bank15 and other central banks are maintaining restrictive monetary policy stances. So although rate cuts are on the horizon, they may not begin until the second or third quarter of 2024. The stance of many central bankers was summed up by Michelle Bullock, Governor of the Reserve Bank of Australia, “we are not yet where we need to be.”16
Business impact
Banks benefitted from higher interest rate margins during the tightening cycle. But higher interest rates have also reduced loan demand and led to deteriorating asset quality — especially in the commercial real estate segment — which has kept downward pressure on banking sector revenues.
Higher bank funding costs and deposit volatility will continue to pressure small and midsized banking institutions, but policy rate cuts should gradually alleviate these pressures.17 Still, with global debt maturities expected to rise from nearly US$2tn in 2024 to a peak of US$2.8tn in 2026, exposure to over-valued debt represents a risk for lending institutions globally.18 Many banks will likely have to mark their loans and bond holdings to market in the coming months.
Several sectors that were most exposed to the higher cost of capital environment – including residential investment, commercial real estate, and small business lending – have faced reduced growth prospects, but lower policy rates may offer refinancing opportunities in the coming months.19 Monetary easing will likely provide a boost to global manufacturing activity as well.
For more information contact Gregory Daco, Marek Rozkrut and Angelika Goliger.