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Amid sharply rising global energy and food prices, inflation has threatened to spiral out of control worldwide, and this is prompting concerted action from major central banks. With inflation hitting multi-decade highs in most economies, central banks are responding by hiking interest rates at a similarly record-breaking pace.
For instance, the Bank of England recently effected its largest rate increase in 27 years, and the previously “dovish” European Central Bank raised interest rates for the first time in 11 years, bidding farewell to a “long chapter of negative rates.”
However, despite the increased synchronicity of central bank measures worldwide, there continue to be outliers. Japan, for instance, has chosen not to implement a rate hike – instead, the country is focused on protecting its currency against a surging dollar. Likewise, even in countries where interest rates have risen, central banks have acted uniquely and with varying levels of urgency. Below, I take a closer look at how major banks in different regions are responding to inflationary pressures below, why they’re raising rates, and what they’re doing differently.
Inflation has been a key topic in economic discourse since mid-2021. Even before the cost-pushing trends caused by the conflict in Ukraine, there were strong signals that central banks would shortly act to reverse the quantitative easing measures implemented to prop economies up against COVID.
Now, with record inflation rates, banks are acting to put the brakes on and prevent entrenched inflationary pressures. By raising interest rates, they increase the cost of borrowing and this in turn reduces the purchasing power of consumers. With less purchasing power, demand for many goods and services should fall, ultimately resulting in lower prices.
As the IMF notes, central banks in emerging markets were the first to start hiking rates in 2021, before being followed by their counterparts in advanced countries. In a roundup of recent rate increases, Reuters reporting indicates that the US lifted rates by 75 bps on September 21 – and projections indicate more planned hikes, potentially bumping rates up to 4.4% by year-end.
The Bank of Canada has also aggressively tightened monetary policy, raising its policy rate to 3.25% – including a 100 bps raise at one point. There are further plans to raise policy rate by 50 bps to 3.75% in October. Meanwhile, the Bank of England has taken a more measured approach, delivering a 50 bps hike on September 22 – less than the 75 bps expected in the market. Nevertheless, money markets see sharper rate hikes on the horizon, with projections of a policy rate of 4.9% by June 2023.
Norway was the first major economy to start hiking rates in 2021, and on September 22 another 50 bps increase brought the country’s policy rate to 2.25%. Likewise, the Reserve Bank of Australia hiked rates for the fifth month in a row, delivering a seven-year high 2.35% policy rate.
Rate hiking action has been slower elsewhere, with Switzerland and the EU playing catch up. The Swiss National Bank only entered positive rates in September, with a 75 bps hike to 0.5% in its second rate increase this cycle. Similarly, the European Central Bank implemented a 75 bps hike in September, raising deposit rates to 0.75% while refinancing rates were up to 1.25% in the highest increase since 2011. Further hikes are likely, with the ECB signaling that rate rises may well continue into 2023.
While conventional wisdom suggests that targeted rate hikes can help control inflation, central banks are wary of overshooting their inflation targets. As Euronews notes, “aggressive monetary policy is a tightrope walk: making money more expensive can slow down growth, weaken salaries, and foster unemployment.”
In a survey conducted in November 2020, McKinsey & Co. found that roughly 80% of European small and medium-sized enterprises (SMEs) viewed their economy as “somewhat to extremely weak”. While the sentiment varied across national economies, SMEs in Italy and Spain were the least optimistic, while Germany had the most optimistic.
Nearly two years later, many of the challenges that informed this SME stance are still unresolved or have worsened in some instances. Businesses across the EU continue to experience difficulties owing to congested supply chains, rising energy costs, and stretched finances.
Likewise, the industries most affected by the pandemic, including hospitality, cultural, creative, food and drinks – which account for a majority of SMEs – are still on a sluggish path to recovery.
Commentators in some quarters suggest that regulatory bodies, such as the European Commission, are not doing enough to help EU SMEs survive and thrive.
I doubt that anyone can deny the overwhelming and far-reaching effects of the COVID-19 pandemic, especially in the SME sector. For a sector that is mostly labor-intensive and dependent on liquidity generated from a steady cadence of demand and supply, the SME sector was amongst the least prepared for the pandemic. Their higher focus on physical selling, coupled with the low rates of digitalization in the sector, meant that when COVID hit, it hit hardest for small companies, including those in Europe.
Explaining why this was the case, Anna Fusari, the European Investment Bank’s head of Banks and Corporates division in the Adriatic Sea region, noted the “thinner liquidity reserves” that SMEs often have. Additionally, “they have limited financial alternatives, and they mostly rely on support from local banks,” says Fusari. “In the majority of cases they lack assets that can be disposed of, or that can be used as collateral for new credit lines.”
While the EU swung into action in passing comprehensive financial and economic measures to broadly support businesses, including SMEs, the situation remains challenging for these companies.
Further, as Christine Lagarde, head of the European Central Bank, admitted in a 2021 speech at the “Jahresimpuls Mittelstand 2021” in Frankfurt, “[the] reality is currently hard for many [SME] firms and the future remains uncertain.”
Yet, this was before the crippling supply chain squeezes recorded from mid-2021 and the energy crisis that has plagued households and businesses since then. Since then, business has gotten much tougher for SMEs who have to contend with runaway business costs while demand has remained static or below pre-pandemic levels in the sectors hardest hit in 2020.
SMEs are a critical component of any economy, particularly in the EU where they contribute 66.6% of jobs and 56.4% of total added value. As I see it, the EU must act with even greater commitment to ensure micro, small, and medium companies in the region experience relief from the highly volatile and uncertain business environment they have endured for the past two plus years.
While the EU has weighed in with unprecedented financial and economic outlays since the pandemic, the sentiment from SMEs is that the aid is either insufficient or only serves as a temporary salve to deeper injuries. Speaking to Financial Times in 2021, Maxime Lemerle, the head of sector and insolvency research at Euler Hermes, highlighted the risk of “zombified companies” that receive just enough liquidity that keeps them on the brink of failure. “These zombified companies in hospitality, retail, transport, leisure and events could go bust very quickly even if the support measures are wound down quite slowly,” says Lemerle.
AAs the World Economic Forum reports, oil prices jumped above $110 per barrel in the weeks after Russia’s invasion of Ukraine. Likewise, natural gas prices more than tripled between mid-February and early March in reaction to the conflict, signaling how the war is affecting energy prices globally.
But in the case of the Russia-Ukraine conflict, energy sensitivities to the war go well beyond volatile price action.
Considering Russia’s status as a significant player in global energy supply and the lengthy profile of countries (including the EU and India) relying on its output, there are other nuanced issues at stake in the conflict.
I outline some of these below.
Energy, being a driver of practically all industry, is a critical global resource. However, the commodity’s volatility – resulting from sensitivity to global or regional disruptions, price seasonality, and industry concerns – makes it an economic wild card at times.
The effects of this price seasonality often vary, but in most cases, it results in disruptions to local and global supply, sharp price hikes, or scarcity in the commodity. Countries are often keen to avoid this outcome, which is one of the reasons why the international community has not placed a coordinated embargo on Russian gas.
In the case of the EU and countries such as Germany, Poland and Bulgaria, these concerns are all the more critical due to their reliance on Russian energy. The EU gets 40% to 45% of its gas from Russia, while Germany, Austria, and Italy fulfill 55%, 80%, and 40% of their respective gas needs from Russia. These countries are largely paralyzed from taking concerted action due to their potential vulnerability to shocks resulting from energy disruptions.
Russia and its trade partners have experienced turbulent economic relationships in the past, particularly in relation to energy agreements. For instance, Russia and Ukraine had a 2008 dispute over a gas transit deal that resulted in Russian gas supply cuts to its neighbor in the dead of winter. Likewise, Russia shut off Ukraine’s gas supply after a 2014 payment dispute, indicating the superior bargaining power of the Russian government.
Russia recently activated these same measures against Poland and Bulgaria (which gets 90% of its gas from Russia) for their failure to pay for gas supply in Russian roubles as opposed to US dollars.
Russia continues to maintain a difficult, and often complex, relationship with its trade partners, especially in Europe and North America. Consequently, responding to the potential of Russian gas shut offs demands opening up alternative supply channels to blunt the effects of any Russian action. But that option will take time to implement, which is a distinctly limited resource in times of war.
While the battle lines in Ukraine seem reasonably clear, the underlying economic relationships underpinning the conflict are much less so. For instance, the two main actors – Russia and Ukraine – continue to maintain energy relations as Ukraine is still a key player in the transit of Russian gas to Europe.
To add some economic leverage to its conflict against Russia, Ukraine has also now activated some of its control over that process, blocking Russian flows to Europe. As a result, natural gas prices in Europe have jumped even higher in the day after this action, adding further complexity to the conflict.
Even the US, which has expressly forsworn energy imports from Russia, is still partly dependent on the country for 16% of its uranium imports, emphasizing the complex interrelationships that underpin the train of events.