Higher for longer: Why are central banks keeping interest rates elevated?
interest rates elevated.
What does higher for longer mean?
Over the past year, various central bankers including Reserve Bank of India governor Shaktikanta Das and US Federal Reserve chairman Jerome Powell have said that tackling high inflation may need interest rates being kept higher for longer. Financial markets, however, had predicted that central banks would start cutting rates by the end of 2022, less than a year after the hiking cycle commenced. Indeed, data shows that the Fed started cutting rates only eight months after its previous hiking cycle ended in December 2018.
The RBI, which ended its last hiking cycle in August 2018, started reducing rates six months later.
Why would interest rates remain high?
Central banks control inflation by hiking rates, making it costlier to access capital and thereby curbing demand in the economy. For most of the 21st century, inflation was absent from advanced economies. However, during the Covid crisis, governments and central banks slashed interest rates and pumped in huge amounts of money to revive their economies.
As activity resumed and pent-up demand burst out, the excess money caused the classical inflation outcome of ‘too much money chasing too few goods’. Global supply chains, already disrupted by the pandemic, saw further ruptures with the Ukraine-Russia war. Consequently, inflation has stubbornly refused to return to official targets.
What happens to financial markets?
Financial markets, which include bonds, stocks, currencies, derivatives, and commodities, are impacted by interest rate changes.
