IMF warns sticky inflation could keep interest rates ‘higher for even longer’

The International Monetary Fund warned that inflation in many major economies has been cooling slower than expected, flagging a potential risk to global growth from interest rates staying higher “for even longer.”

The Washington-based lender, in an update to its flagship World Economic Outlook released on Tuesday, zeroed in on stubborn services inflation, mainly driven by higher wages. It also pointed to price pressures from trade and geopolitical tensions, particularly on commodities like oil.

“Services price inflation is holding up progress on disinflation, which is complicating monetary policy normalisation,” the IMF said. “Upside risks to inflation have thus increased, raising the prospect of higher-for-even-longer interest rates.”

IMF chief economist Pierre-Olivier Gourinchas says interest rates may have to remain elevated for longer.Credit: AP

Despite those warnings, the IMF sees the global economy still poised for a soft landing. It raised the growth outlook for next year by 0.1 percentage point to 3.3 per cent and left this year’s forecast unchanged at 3.2 per cent. However, “there have been notable developments beneath the surface,” Chief economist Pierre-Olivier Gourinchas said in an accompanying blog post.

After the US economy’s better-than-expected performance while China lagged, economic output during the first quarter converged across many countries, with Asia emerging again as the major driver, while America’s hot streak cooled.

The IMF revised its outlooks for China and India, which will account for nearly half of global growth, and predicted that the euro area is also poised to pick up.

Stubborn US inflation figures earlier this year pushed expectations for cuts by the Federal Reserve out to September at the earliest, when the European Central Bank may return to easing after an initial cut in June.

“We didn’t gain any additional confidence in the first quarter but the three readings in the second quarter, including the one from last week, do add somewhat to confidence” that inflation is heading toward the Fed’s 2 per cent goal, Fed Chair Jerome Powell said on Monday.

Higher US rates for longer will also sustain upward pressure on the dollar, complicating emerging-market inflation, interest rates, growth and debt.

Gourinchas also cautioned that government balance sheets are weak coming out of the pandemic, leaving them vulnerable to new shocks. He took particular aim at the US, writing that it’s “concerning that a country like the United States, at full employment, maintains a fiscal stance that pushes its debt-to-GDP ratio steadily higher, with risks to both the domestic and global economy.”

“The worry here is the more short-term funding you have in the structure of your debt, then the more often you need to go to the market and renew that funding,” Gourinchas said in a briefing on Tuesday. “It’s usually cheaper at the short end of the curve, but it is also a little bit riskier.”

A 0.4 percentage-point upgrade to the IMF’s China growth forecast, bringing it to 5 per cent this year and 4.5 per cent next, was fuelled by a rebound in private consumption and strong exports in the first quarter. The slowdown in the second quarter indicates lingering issues around consumer confidence and the property sector, Gourinchas said in the briefing, adding that the IMF has warned of this risk and now it “seems to be, perhaps, materialising.” The IMF sees growth in the world’s second-biggest economy slowing to 3.3 per cent by 2029.

One possible boost to consumption, investment and growth will come from Beijing’s recent push for trade-ins and upgrades of household and industrial equipment, said Jean-Marc Natal, the division chief of the IMF’s Research Department. “We have been recommending a shift toward consumption in the last few years, and this is one step in the right direction,” he said.

The IMF raised its growth forecast for India to 7 per cent, also on a better outlook for private consumption, particularly in rural areas.

The biggest growth downgrades went to Saudi Arabia, cut by 0.9 percentage points to 1.7 per cent amid oil output reductions coordinated with OPEC+, and Argentina, down 0.7 percentage points to a 3.5 per cent contraction as President Javier Milei enacts severe spending cuts.

Bloomberg

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