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IMF warns central banks about the “final mile of deflation.”

Apr 22, 2024 | International | 0 comments

The International Monetary Fund (IMF) has advised central banks to remain vigilant in what it calls the “last mile of disinflation” as inflation is expected to ease in the coming months. In a blog based on the April 2024 Global Financial Stability Report, the IMF stated that a sense of optimism has prevailed in financial markets recently, with investor confidence that the fight against inflation is nearing its end and that central banks will ease monetary policy.

Stock markets worldwide have seen substantial rises this year, and corporate and sovereign borrowing spreads have narrowed. Major emerging markets ‘ currencies and capital flows have remained resilient, while several frontier markets have regained access to international funding markets. However, the IMF warns that there could be bumps along this last mile, including potential geopolitical tensions and strains in commercial real estate.

The IMF pointed out that debt vulnerabilities continue to grow, with both the public and private sectors in many countries borrowing heavily despite high-interest rates. Recent evidence suggests that disinflation may have stalled in some countries, and underlying inflation may be persistent in some sectors. Core inflation has come in higher than analyst forecasts for consecutive months in some cases, challenging the last-mile narrative and related investor optimism.

Inflation has diverged recently across countries, with core inflation accelerating in the most recent three months versus the three months prior in several major advanced and emerging economies. Expectations for inflation in major economies over the next year or two have been climbing, remaining above central bank target levels in several countries.

The IMF warns of the potential for an intensification of geopolitical tensions, which could disrupt shipping and energy production and push up inflation once again. Financial markets have remained broadly confident about stalling disinflation and other headwinds and risks, with volatility in major asset classes currently at low levels despite elevated measures of economic policy uncertainty.

Investors anticipate substantive policy rate cuts this year despite a string of upside inflation surprises in the United States. However, if inflation remains high, such lofty expectations could lead to a correlated selloff of assets, from bonds to stocks to crypto assets, and could broadly tighten financial conditions globally. Emerging market borrowers are often disproportionately affected in these situations.

The stalling of disinflation may surprise investors who are increasingly convinced that the battle against inflation has already been won and that low rates will prevail again. In economies still experiencing persistent and above-target inflation, central banks should not prematurely ease to avoid having to backpedal later. They should also push back against overly optimistic investor expectations for monetary policy easing, which has led to some exuberance in financial markets. Of course, where progress on inflation suggests it is moving sustainably toward the target, central banks should gradually move to a less restrictive stance of policy.

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