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Tag: Central banks

  • IMF cautions Central Banks to maintain tight monetary policy amid consistent inflation declines

    IMF cautions Central Banks to maintain tight monetary policy amid consistent inflation declines

    The International Monetary Fund (IMF) has advised nations like Ghana, where inflation remains above the central bank’s target range, to continue enforcing a tight monetary policy.

    Despite a consistent decline in inflation in recent months, the IMF cautioned against relaxing monetary policy rates too soon for countries facing such circumstances.

    Luc Eyraud, the IMF Division Chief for Africa, delivered this message during a press conference in Accra. He suggested that while Ghana and similar nations could consider halting increases in the policy rate, reducing them at this stage would be premature.

    In sub-Saharan Africa, headline inflation has been decreasing since reaching its peak in November 2022. However, about a third of countries still experience double-digit inflation due to significant currency depreciations. Even among nations with declining inflation rates, most have opted to maintain or tighten their policy rates.

    In Ghana, the economy has grappled with high inflation, reaching a 22-year high of 54.1% in December 2022. Responding to this challenge, the Bank of Ghana’s Monetary Policy Committee consistently raised the policy rate, reaching 30% by the end of 2023.

    As inflation eased to 23.2% in December 2023, the central bank reduced the policy rate to 29% in January 2024 for the first time in two years. This rate has since been maintained.

    As the BoG prepares for its third Monetary Policy Committee meeting of the year, there are calls from the business community to further reduce the policy rate to facilitate cheaper access to finance. However, with 2024 being an election year, there are predictions that the central bank may relax the policy rate to support economic growth.

    Despite these expectations, the IMF has advised against premature relaxation of the policy rate. As of March 2024, Ghana’s inflation rate stood at 25.8%, significantly above the central bank’s target range of 6%-10%.

    Easing inflationary pressures

    Mr Eyraud noted that about half of the countries in sub-Saharan Africa show clear signs of easing inflationary pressures, with inflation already below or within their target bands.

    He said central banks in such countries may consider gradually easing to a more neutral policy stance to allow for more accommodative financing conditions, boosting private investment and mitigating the impact of fiscal consolidation.

    He added that in nearly one-third of the countries, inflation was trending lower but moderately exceeded targets.

    “In such countries, a pause in policy tightening may be warranted to ensure confidence in achieving price stability but it may be a bit too early to reduce the rate.

    “As for the rest, where inflation significantly exceeds target policy rate and continues to rise, policymakers should decisively tighten monetary policy until inflation is firmly on a downward trajectory and projected to return to the central bank’s target range,” he stated.

    He said maintaining price stability should be the immediate goal.

    Debt sustainability

    Also speaking at the press conference, IMF Deputy Director, Catherine Pattillo, said the fund was in the process of reviewing its debt sustainability framework to reflect changes in the global environment.

    She said in its debt sustainability analysis, the fund looks at all the debt indicators, including growth indicators, exports and revenue, to come up with an assessment.

    “But going forward, we are going to review our debt sustainability framework to ensure we pay good attention to things that are changing in the ways countries are borrowing,” she stated.

    She said the review would look at the change in creditors, as countries are now opting for more domestic debt, the risks and benefits that come with it and also look at the climate shocks and how they affect debt sustainability.

    In order to achieve debt sustainability, Ghana has completed a restructuring of its domestic debt and is in the process of restructuring its bilateral debt and external commercial debt.

    The domestic debt restructuring exercise saw the government swap old bonds worth GH¢82 billion for 12 new ones at reduced coupon rates and longer tenors.

    The country, also in January this year, reached an agreement with the Official Bilateral Creditor Committee (OCC), co-chaired by France and China, to restructure bilateral debts of about $5.5 billion.

    The government is still in discussion with the OCC to formalise the agreement through a memorandum of understanding.

    On the external commercial front, the government has opened fresh talks with its Eurobond holders to make some slight changes to the interim agreement reached with the investors.

    This is because the interim agreement reached falls short of the debt sustainability targets set by the IMF under its three-year programme with Ghana.

    The country is seeking to restructure commercial debts of about $14 billion, out of which $13 billion is in Eurobonds.

    Return to capital market

    On when countries like Ghana could re-assess the international capital market, Ms Pattillo said this would depend on domestic and external conditions, as the uncertainties in the global finance market remain.

    She, however, noted that with the good progress being made by Ghana under the IMF programme, it may not be long for the country to regain access to the international capital market.

    After a two-year hiatus, African countries have made a comeback to the international capital market, with Cote D’Ivoire, Kenya and Benin issuing Eurobonds this year.

    Ms Pattillo said this was a positive sign for the region, adding that it was a sign that the market sentiment for the region was improving.

    She, however, noted that the Eurobonds have been pricey due to the high-interest rate regime globally.

    “The yields are much higher than pre-pandemic,” she stated.

  • Uncertain financial conditions present a challenge to central banks

    Uncertain financial conditions present a challenge to central banks

    Central banks aggressively hiked interest rates last year as inflation in many countries rose to the highest levels in decades. Now, falling energy prices are reducing headline inflation and fuelling optimism that monetary policy may be eased later this year.

    Such expectations have caused a sharp decline in global longer-term interest rates and boosted financial markets in advanced economies and emerging markets alike.

    Though this may make it tempting to conclude that monetary policy is becoming overly restrictive and poised to cause an unnecessary economic contraction, investors may be too sanguine about progress on disinflation. While headline inflation has indeed fallen, and core inflation has receded slightly in some countries, both remain far too high. Central banks must, therefore, be resolute in their fight against inflation and ensure policy remains appropriately tight long enough to durably bring inflation back to target.

    Aggressive tightening

    After many years of low inflation, the surge in inflation during the pandemic recovery came as a surprise. Key factors driving inflation included supply disruptions, high energy prices following Russia’s invasion of Ukraine and massive monetary and fiscal stimulus that fuelled spending on housing and durable goods. Inflation topped six per cent in more than four-fifths of the world’s economies while increasingly broad-based price gains lifted expectations for further increases to multi-decade highs.

    Central banks in emerging markets responded by sharply tightening policy beginning in 2021, followed by their counterparts in advanced economies. This led to a tightening of financial conditions globally through the fall of last year. As a result, global economic growth is now expected to slow this year, with divergent views on the extent to which unemployment would likely need to rise to cool hot labour markets.

    Investor optimism

    Since late last year, however, financial markets have rebounded strongly on retreating energy prices and signs that inflation may have peaked. In some economies, prices for goods included in core inflation measures, such as autos and furniture, have fallen.

    These signs of progress in reducing inflationary pressures amidst continued strength in labour markets have offered reason to believe that policy makers may have succeeded in taming inflation with little cost to economic growth, a so-called soft landing.

    In the United States(US) and the Euro area, market-based measures of inflation one year ahead have returned to near the central banks’ two per cent target from six per cent last spring. Gauges for several other advanced economies have seen similar drops. In emerging markets, such market-based measures of inflation one year ahead have also been falling, albeit at a slower pace.

    Expected easing

    These disinflation hopes have been accompanied by growing expectations that central banks will soon not only stop tightening policy but also reduce rates fairly quickly. In many economies, this has led to yields on long-dated government debt falling below short-dated maturities. Historically, such an inversion of the yield curve often precedes recessions. Analyst assessments, in fact, point to significant recession risk in many economies, but the expectation is that recessions, should they occur, will be mild.

    Growing expectations for lower interest rates and a shallow economic slowdown have fuelled a significant easing in financial conditions in recent months—despite central banks continuing to raise rates. Markets have reflected this relatively benign picture: stock markets have rallied and credit spreads narrowed considerably.

    Conundrum for central banks

    This easing of financial conditions during a central bank tightening cycle creates a conundrum for policy makers.

    On the one hand, financial markets are signalling that disinflation may occur without meaningful increases in unemployment. Policy makers could embrace that view and in effect ratify the loosening of financial conditions. Many observers concerned that central banks will be overzealous about tightening monetary policy—and will cause an unnecessarily painful economic downturn—are endorsing such a view.

    Alternatively, central banks could push back against investor optimism, emphasising the risks that inflationary pressures may be more persistent than expected. This risk-management approach would require restrictive interest rates for longer until there’s tangible evidence of a sustained decline in inflation.

    While doing so could induce a repricing of the policy path and of risk assets in financial markets—possibly causing equity prices to fall and credit spreads to widen—there are three reasons why such an approach is needed to ensure price stability.

    • History shows high inflation is often persistent—and may possibly ratchet up further—without forceful and decisive monetary policy actions to reduce it.

    • While goods inflation has come down, it seems unlikely that the same will happen for services without significant labour-market cooling. Crucially, central banks must avoid misreading sharp declines in goods prices and easing policy before services inflation and wages, which adjust more slowly, have also moderated markedly.

    • Experience suggests that prolonged periods of rapid price gains make inflation expectations more susceptible to de-anchoring as such an inflationary mindset becomes more entrenched in the behaviour of households and firms.

    Policy makers must continue to be resolute

    Central banks should communicate the likely need to keep interest rates higher for longer until there is evidence that inflation—including wages and prices of services—has sustainably returned to the target.

    Policy makers will likely face pressure to ease policy as unemployment rises and inflation keeps falling. These challenges could be particularly acute for emerging market economies.

    To be sure, this is an unusual period in which many special factors are affecting inflation, and it is possible that inflation comes down more quickly than policy makers envision. However, loosening prematurely could risk a sharp resurgence in inflation once activity rebounds, leaving countries susceptible to further shocks, which could de-anchor inflation expectations. Hence, it is critical for policy makers to remain resolute and focus on bringing inflation back to target without delay.