After bailing out the First Republic, economists expect more pain

  • Central banks around the world have been aggressively raising interest rates for more than a year in an effort to curb soaring inflation.
  • But economists have warned in recent days that price pressures are likely to remain elevated for much longer.
  • Nearly 80% of senior economists surveyed by the World Economic Forum said that central banks face a “trade-off between managing inflation and maintaining financial sector stability”.

Federal Reserve Chairman Jerome Powell holds a press conference after the Federal Reserve raised interest rates by a quarter of a percentage point following a two-day meeting of the Federal Open Market Committee (FOMC) on interest rate policy in Washington, March 22, 2023.

Leah Mellis | Reuters

After First Republic Bank was bailed out by JPMorgan Chase over the weekend, leading economists expect a prolonged period of higher interest rates to lead to further weakness in the banking sector, which could hurt central banks’ ability to rein in inflation.

The US Federal Reserve will announce its latest monetary policy decision on Wednesday, and the European Central Bank will follow closely on Thursday.

Central banks around the world have aggressively raised interest rates for more than a year in an effort to curb soaring inflation, but economists have warned in recent days that price pressures look likely to remain elevated for much longer.

The World Economic Forum’s Chief Economist Outlook Report published on Monday highlighted that inflation remains a major concern. Nearly 80% of the top economists surveyed said central banks face “a trade-off between managing inflation and maintaining financial sector stability,” while a similar proportion expect central banks to struggle to reach their inflation targets.

“Most senior economists expect central banks to play a very delicate dance between the desire to cut inflation further and the financial stability concerns that have also arisen in the past few months,” Zahidi told CNBC Monday.

As a result, she explained, this trade-off will become more difficult, as about three-quarters of the economists surveyed expected that inflation would remain high, or that central banks would be unable to act quickly enough to bring it down to the target.

First Republic Bank became the latest victim over the weekend, the third among mid-sized US banks after the sudden collapse of Silicon Valley Bank and Signature Bank in early March. This time, it was JPMorgan Chase that came to the rescue, as the Wall Street giant won an auction over the weekend for the beleaguered regional lender after it was seized by the California Financial Protection and Innovation Administration.

CEO Jamie Dimon claimed the decision marked the end of recent market turmoil as JPMorgan Chase acquired nearly all of First Republic’s deposits and the majority of its assets.

However, rising inflation and increasing financial instability remain, several prominent economists told a panel at the World Economic Forum’s Growth Summit in Geneva on Tuesday.

“People have not centered around this new era, where we have an era that is going to be more structurally bloated, a post-globalization world where we are not going to have the same volume of trade, there are going to be more trade barriers,” said Karen Harris, managing director of macro trends at Bain & Co. company: “

“And we have a declining workforce, which requires investment in automation in many markets, and therefore less capital generation, less movement of capital and goods, more demand for capital. That means inflation, the inflationary impulse will be higher.”

Harris added that this does not mean that actual rates of inflation will be higher, but rather that it requires that real rates (which are adjusted for inflation) be higher for longer, which she said creates “a lot of risk” in that the “calibration era of low rates has become so entrenched Getting used to higher rates, this determination, will create failures that we have not yet seen or expected.

She added that it “defies logic” that while the industry is trying to shift quickly to a higher interest rate environment, there will be no further losses beyond SVB, Signature, Credit Suisse and First Republic.

After the sudden rise in interest rates over the past 15 months or so, central banks will likely want to “wait and see” how this shift in monetary policy plays out through the economy, said Jorge Cecilia, chief economist at BBVA Group. However, he said the biggest concern is potential “pockets of instability” that the market is not currently aware of.

“In a world where the leverage is so high because you have very low interest rates for a long period of time, where the liquidity will not be as sufficient as before, you will not know where the next problem will go,” Sicily told the committee.

He also drew attention to the recent IMF Financial Stability Report’s reference to the “interdependence” between leverage and liquidity and these pockets of instability.

“If the interdependence of pockets of instability does not go into the banking system that normally provides the lending, it need not create a huge problem, and therefore, central banks can continue to focus on inflation,” Cecilia said.

“This does not mean that we will not experience instability, but it does mean that it will be worse down the road if inflation does not come down to levels close to 2 or 3%, and central banks are still around.”

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