Rapid hike in interest rates has led to ‘financial vulnerabilities’, OECD warns

Agency’s interim outlook says interest rates likely to peak at 4.25% in euro zone and 5.25-5.5% in US

The OECD said inflation will moderate gradually over 2023 and 2024 but is likely to remain above central bank objectives until the latter half of 2024 in most countries.
The OECD said inflation will moderate gradually over 2023 and 2024 but is likely to remain above central bank objectives until the latter half of 2024 in most countries.

The speed of monetary tightening globally has exposed “financial vulnerabilities”, particularly in the banking sector, despite an improving global economic outlook, the Organisation for Economic Co-operation and Development (OECD) has warned.

In its latest interim outlook, the Paris-based agency said the full impact of higher interest rates was hard to gauge, warning that increased stress for borrowers could translate into losses for some banks.

It said the hike in rates continued to expose “financial vulnerabilities from high debt and stretched asset valuations, and also in specific financial market segments”.

The OECD’s report comes on the back of major market turbulence triggered by the collapse of California’s Silicon Valley Bank (SVB) and the high-profile bailouts of European bank Credit Suisse and US lender First Republic.

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The European Central Bank lifted interest rates by a further half percentage point on Thursday to fight inflation, despite growing concern about the impact of higher rates on financial markets.

ECB rate hike raises costs for almost 250,000 mortgage holdersOpens in new window ]

The OECD projected that central bank policy rates would peak at 5.25-5.5 per cent in the US and 4.25 per cent in the euro zone.

After growth last year of 3.2 per cent, the global economy is on course to expand at a slower rate of 2.6 per cent in 2023 as central bank tightening takes full effect, it said. This was, however, up from a forecast of 2.2 per cent previously.

The improved outlook was linked to a decline in energy and food prices and China’s easing of its anti-Covid restrictions.

“More positive signs have now started to appear, with business and consumer sentiment starting to improve, food and energy prices falling back, and the full reopening of China,” it said.

Nonetheless, global growth is projected to remain below trend rates in 2023 and 2024, at 2.6 per cent and 2.9 per cent respectively, with policy tightening continuing to result in a drag on growth.

While headline inflation is declining, the OECD warned that core inflation, which strips out energy and food, remains elevated, “held up by strong service price increases, higher margins in some sectors and cost pressures from tight labour markets”. That comment comes as figures from Eurostat on Friday showed core inflation in the euro zone rising – up from an annualised rate of 5.3 per cent in January to 5.6 per cent, even as the headline consume price index edged down to 8.5 per cent from 8.6 per cent a month earlier.

Euro zone inflation cooled in February but underlying prices pick upOpens in new window ]

The agency said inflation is projected to moderate gradually over 2023 and 2024 but to remain above central bank objectives until the latter half of 2024 in most countries.

“The improvement in the outlook is still fragile. Risks have become somewhat better balanced, but remain tilted to the downside,” the OCED said.

One of the chief risks to the global economy remains the war in Ukraine, it said, while noting “pressures in global energy markets could also reappear, leading to renewed price spikes and higher inflation”.

Eoin Burke-Kennedy

Eoin Burke-Kennedy

Eoin Burke-Kennedy is Economics Correspondent of The Irish Times