The International Monetary Fund (IMF) has issued a warning message to the global economy, particularly the US and UK. The warning? Fasten your seatbelts, because the recent interest rate hikes to combat inflation may keep things volatile for longer than expected.
IMF predicts high interest rates for US and UK for a long time
The news comes as central banks such as the Bank of England grapple with the delicate task of containing inflation without stifling economic growth. The Bank of England, for example, has been aggressively raising interest rates, which are now at a 16-year high of 5.25%.
The strategy appears to be working, with UK inflation approaching the 2% target, but prices continue to rise in some areas, particularly the services sector. What the IMF's chief economist Pierre-Olivier Grunschas has called “persistent inflation” suggests the fight against inflation may not be over yet.
The IMF's concern is two-fold. First, the momentum of global disinflation is slowing, signaling potential obstacles on the path to price stability. Second, persistent inflation increases the likelihood that interest rates will remain high for a prolonged period, which could exacerbate existing financial risks and strain government finances.
Beyond the base rate: cascading effects
Rising interest rates are a double-edged sword. On the one hand, higher interest rates can lower inflation by making borrowing costs higher and encouraging savings, but they can also slow economic activity. High borrowing costs can discourage businesses from investing in expansion projects and encourage consumers to cut back on discretionary spending. This can slow economic growth and even lead to a recession.
Bright spots for the UK
But there is some optimism: the IMF has slightly raised its global growth forecast for 2025 to 3.3%, signalling a potentially stronger future. Moreover, for the UK, the IMF has raised its growth forecast to 0.7% in 2024.
Turning to the UK, financial markets seem cautiously optimistic. The interest rate on two-year government bond (gilt) notes fell below 4% for the first time in 2024, suggesting a growing expectation that interest rates may be cut in the near future. This development could lead to further competition among mortgage lenders and a fall in fixed mortgage rates even before the Bank of England's next policy decision in August.
Election uncertainty and the debt dilemma
Beyond immediate economic concerns, the IMF highlights the potential impact of political uncertainty on global economic growth. Upcoming elections around the world could lead to significant policy changes that could affect the trajectory of economies. The IMF acknowledges that it is still too early to assess the potential economic impact of a new Labour government in the UK, but notes that some of its plans are consistent with IMF recommendations for the UK economy.
On the other side of the Atlantic, the IMF has expressed concern about the growing national debt of the United States. When a government borrows more, it typically raises borrowing costs, which can affect mortgage rates and consumer and other loans. Higher borrowing costs can create a vicious cycle as the government may need to borrow more to meet its spending obligations.
The looming threat of a trade war
The report also highlights the dangers of increasing trade barriers. The significant increase in trade restrictions, including export restrictions and tariffs, seen in recent years could provoke retaliation and hinder global economic activity. The IMF urges countries to refrain from such measures to prevent a “costly race to the bottom” that would undermine all parties involved. A healthy global trading environment is essential for the efficient allocation of resources and fostering economic growth across borders.
In summary, the IMF's message is clear: fighting inflation is not a sprint but an ongoing marathon. Despite signs of progress, interest rates are likely to remain elevated for a long time. Global economic growth is expected to improve slightly but faces challenges including political uncertainty and increasing trade barriers. International cooperation and responsible economic policies are essential to navigate these complex conditions and ensure a stable and sustainable global economic recovery.
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