Above: Nouriel Roubini speaking on September 18th.Image courtesy of Bloomberg.
The Bank of England’s apparent plan to halt the rate hike cycle after raising interest rates to 5.50% this week is a mistake, according to a leading economist.
Instead, the World Bank should “raise interest rates to 5.75%,” said Nouriel Roubini, a professor of economics and international business at New York’s Stern School of Business.
Roubini, who rose to fame by predicting the 2008 financial crisis, said the central bank must keep raising interest rates to avoid “true stagflation.”
Stagflation refers to an economy suffering from high inflation and low growth, which is considered an unfavorable backdrop for currencies and financial assets associated with that country. Concerns about stagflation are why many analysts are bearish on the outlook for the pound.
In an interview with Bloomberg, Roubini said the Bank of England and the European Central Bank faced a dilemma: “On the one hand, with the reduction in economic activity, it will probably come to a halt at this point. On the other hand, If inflation remains well above global levels, further increases may be necessary to reach the target.
The Bank of England has signaled through its Governor and Chief Economist that the end of the rate hike cycle is near, with investors pricing in one more rate hike scheduled for next Thursday.
The decline in expectations for rate hikes (the market at one point saw the bank rate peaking at around 6.5%) coincides with the underperformance of sterling since August.
Roubini said recent dovish signals from the central bank were “troublesome.”
He said: “The signals indicate they are not sure if they want to hike further.” Without further rate hikes, “inflation could become unlocked and true stagflation could occur.”
This refers to a situation in which consumers and businesses expect inflation to remain high for an extended period of time, causing workers to demand higher wages and businesses to raise prices, creating an inflationary spiral.
This is something that Katherine Mann, a member of the Bank of England’s Monetary Policy Committee, has been warning about for years.
man said in her recent speech She would rather raise rates “too much,” rather than raise them too little and contribute to a situation where inflation remains high for an extended period of time.
Ultimately, further rate hikes will be necessary in the future.
Roubini said inflation will remain high due to structural changes in the global economy, from population aging to the geopolitics of supply chains.
As a result, the central bank will need to raise its inflation target from 2% to 3% or 4% over time, he said.
“There are factors on both the supply and demand side that suggest that 2% is mission impossible at the moment. And the new normal for developed countries will change over time, not overnight, of course, but at 3%. It could be anywhere between 4% and 4%,” Roubini said.
But Panmure Gordon economist Simon French said he had to “respectfully disagree” with Roubini’s views.
“There is a lot of evidence that (market and survey-based) price expectations temporarily absorbed the upside surprises in Q1 and Q2, namely core CPI and wages,” he explains.
The French government has stated that the rate hike equivalent to +515 basis points has been slow to spread through the economy, and that raising interest rates by more than 5.5% “risks a policy error.”