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Central banks must keep interest rates high to combat inflation, says OECD

Central banks should maintain the fight against inflation with high interest rates despite fears of a global banking crash, according to the OECD, which said the UK will be the only economy in the G20 apart from Russia to shrink this year.

The Organisation for Economic Cooperation and Development said it was concerned that inflation remained stubbornly high in many of its 39 members countries and urged central banks to persist with interest rate increases when necessary.

Álvaro Pereira, the Paris-based organisation’s interim chief economist, said services companies were continuing to push through strong price rises, even though wholesale energy and food prices were falling.

“Services price growth has remained high, pushing up core inflation, which is why we believe central banks must remain vigilant,” he said.

Some economists have said further interest rate rises by major central banks, including the Bank of England, will undermine the stability of the global financial system, which has become accustomed to ultra-low borrowing costs since the 2008 financial crash.

The collapse of Silicon Valley Bank in the US, the sale of its UK offshoot to HSBC for £1 and the rescue of Credit Suisse after being thrown a $54bn lifeline by the Swiss central bank have spooked global markets.

The European Central Bank president, Christine Lagarde, said on Thursday after she announced a 0.5 percentage point increase in the interest rate covering the 19-member euro bloc, that the fight against inflation remained a priority. She said the bank had the financial tools and necessary reserves should there be European banks in need of extra resources.
US central bank policymakers and the Bank of England could follow suit when they meet on Wednesday and Thursday, respectively, though many economists have cut the odds on both unveiling a rise amid ongoing fears of a broader banking crisis.

The Bank of England governor, Andrew Bailey, and its chief economist, Huw Pill, already played down the need for a rate increase based on projections that inflation is falling faster this year than expected.

The OECD, which forms a triumvirate of global economic institutions alongside the International Monetary Fund and the World Bank, said all major EU economies will expand in 2023 at a stronger pace than it had forecast last year, leaving Britain and Russia the only members of the G20 group of wealthy nations to suffer a decline.

In its half-yearly outlook, it said the UK economic forecast had improved slightly compared with its prediction in November of a 0.4% contraction, largely in response to falling gas prices, but it would still shrink by 0.2% this year.

Under the heading “a fragile recovery”, the OECD said it expected to see a further rebound in consumer confidence and business output this year across its member states – which include other G20 countries such as Mexico, Indonesia, South Korea and the US, but not Russia, as well as smaller nations such as EU states.

The OECD said there were “more positive signs” now that food and energy prices were falling back, and the Chinese economy had fully reopened.

However, the slow recovery from the coronavirus pandemic would continue while central banks kept interest rates high and the Ukraine war persisted.

Global growth is projected to remain at below trend rates in 2023 and 2024, at 2.6% and 2.9%, respectively, with policy tightening continuing to take effect. Nonetheless, a gradual improvement is projected through 2023-24 as the drag on incomes from high inflation recedes,” it said.

Last year, the organisation said the UK would be the economy hit hardest by the Ukraine war.

Unlike the economic forecasts for the UK by the Office for Budget Responsibility, the OECD expects growth in the UK to remain weak next year, rising to only 0.9%. The OBR, which provides independent forecasts for the Treasury, said earlier this week it estimates the UK economy will grow by 1.9%.

The UK has one of the highest rates of inflation, the biggest reliance on gas and the lowest labour productivity – defined as output per hour – among its major competitors, Pereira said.

Inflation in the UK is expected to fall from above 10% this year, higher than France, Spain, the US and Japan, to be among the lowest in the G20 by the end of the year at below 3%.

Pereira said the situation in the UK “will be difficult over the next few months as the economy contracts” before a recovery in consumer spending and business investment in the second half of 2023 and 2024 that will spur a modest turnaround.

There are wide gaps between the forecasts for the UK next year by the OECD, the OBR and the Bank of England, which expects GDP growth to be only 0.4% in 2024.

The OBR said this week it was more optimistic mainly because of government policies outlined in the budget to bring workers back into the labour market and a judgment that household savings accumulated during the pandemic will be spent in an effort to maintain living standards.
Source: The Guardian

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