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Central banks must act decisively as stagflation risks loom: BIS

FRANKFURT — Central banks around the world must act decisively to rein in inflation and avoid the global economy getting slammed by high prices and low growth, the Bank for International Settlements warned on Sunday.

“Stagflation dangers loom large, as a combination of lingering disruptions from the pandemic, the war in Ukraine, soaring commodity prices and financial vulnerabilities cloud the outlook,” the BIS wrote in its annual report. “The priority for central banks is to restore low and stable inflation.”

As central banks pick up their fight against inflation, they should aim to minimize the hit to economic activity, according to the Basel-based institution, known as the bank for central banks.

“Engineering such a ‘soft landing’ has historically been difficult, and the starting conditions today make it challenging,” the BIS acknowledged, pointing to the current backdrop of high debt and overvalued asset prices.

The report’s warnings echo those of U.S. Federal Reserve Chair Jerome Powell, who said on Wednesday that a soft landing “is going to be very challenging,” and that a recession is “certainly a possibility.”

Despite these competing tensions, the priority should be bringing down inflation first, wrote BIS General Manager Agustín Carstens, who previously headed the Bank of Mexico.

“The key for central banks is to act quickly and decisively before inflation becomes entrenched,” Carstens said. “If it does, the costs of bringing it back under control will be higher. The longer-term benefits of preserving stability for households and businesses outweigh any short-term costs.”

The Fed has already raised interest rates three times, while the Bank of England has lifted its rates five times. The ECB, by contrast, has remained on hold, signalling its first move for July.

A souring growth outlook for the eurozone, however, has some economists counselling caution on tightening. “Just weeks before the first rate hike in more than a decade, demand has already slowed markedly,” said ING economist Bert Colijn on Thursday.

The ECB, for its part, has rejected the notion that the eurozone will fall into stagflation, pointing out that all forecasts suggest growth will remain around 2 percent and inflation will return to the central bank’s 2 percent target in the second half of next year.

Notably, a repeat of the 1970s stagflation is unlikely due to improved monetary policy and macroprudential frameworks and less vulnerability to energy shocks, the BIS wrote.

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