Central banks must maintain a “higher for longer” rate approach, according to the IMF

Central banks around the world need to make clear to financial markets the likely need for interest rates to stay higher for longer to sustainably return inflation to target and avoid a rebound in pressures. on prices, the International Monetary Fund said on Thursday.

The warning has been issued against a backdrop of significantly loosening financial conditions since October, as investors put aside last year’s sharp rise in interest rates by central banks, designed to lower a rate. inflation that exceeded 6% in more than 80% of the world’s economies.

Instead, as central banks near a ceiling on interest rates and inflation has started to recede, investors have bet on a quick turn towards rate cuts.

“Central banks should communicate the likely need to keep interest rates higher for longer until there is evidence that inflation – including wage and service prices – has sustainably returned to target”, the head of the IMF’s Monetary and Capital Markets Department, Tobias Adrian, and his two deputies wrote in a blog.

“Easing prematurely could trigger a sharp rebound in inflation once activity picks up, leaving countries exposed to further shocks that could unanchor inflation expectations”, they added.

The disconnect became apparent on Wednesday, when the US Federal Reserve raised its key interest rate and its chairman, Jerome Powell, reiterated that the central bank does not plan to cut rates this year as it needs to see disinflation of goods followed by marked progress in the services sector, which is expected to take longer.

Investors ignored his words and continued to bet that the Federal Reserve will cut rates this year, while stocks rose. The S&P 500 stock index is up more than 7% this year and more than 15% since its low in mid-October.

A more comprehensive weekly measurement of US financial conditions by the Chicago Federal Reserve shows that they are currently looser than the historical average.

Financial markets reacted in a similar way on Thursday, when the European Central Bank and the bank of england interest rates went up.

The IMF noted that history shows that high inflation often persists in the absence of monetary policy measures “energetic and decisive” and that, although the inflation of goods has decreased rapidly, it is unlikely that the same advance will take place in the services sector if a significant cooling of the labor market is not known.

“Central banks should avoid misinterpreting sharp declines in goods prices and ease monetary policy before more slowly adjusting wage and services inflation have also moderated markedly,” the authors wrote. “It is critical that policymakers stand firm and focus on bringing inflation back to target without delay.”