Banks are the backbone of financial system that help central bank to control money supply in the economy by adjusting the interest rates time to time. Greater money supply lead to higher inflation as availability of surplus increases purchasing power of individuals. The same situation arose when the world was battling with COVID in 2020 during which lockdown was imposed by government to stop the infection, manufacturing activity was halted and a large number of population, particularly who are under below poverty line, were struggling for livelihood. Then, central banks announced various packages to support the liquidity in the system and injected a large amount of money into the system. At that time, it helped a lot but thereafter it pushed the commodity prices higher and the situation of higher inflation is in front of you today. It has become a burning economic issue for all central banks in recent times. There are also other major reasons that contributed in price instability like geopolitical tensions and increasing interest rates. In USA, inflation rate was 6.00% in Feb’23 while it was 10.40% in UK and 9.90% in European Union (EU) as shown in Figure 1.
Fed, RBI, BOE, BOA, ECB and many other central banks raised their interest rates aggressively in the last few months with an objective of reducing inflationary pressure on the economy. At some extent, it has reduced but higher cost of capital are hitting the economy now. Rush of withdrawal by depositors to get the benefit of high interest rates are increasing stress on the banking system. Collapse of SVB and Signature bank, shut down of Silver gate Capital, failure of Credit Suisse and now tumbling share of Deutsche bank are recent examples that clearly showed the distress in the banking system. Although, intervention of Fed and swap credit line arrangements helped to boost the investor’s confidence, but still the sentiment is fragile. Simultaneously, looming recession fears are also growing day by day as central banks are announcing rate hikes one by one. Recently, Fed hiked fund rates by 25bps while ECB, SNB, BOE also decided to increase their policy rates by 50bps in Mar’23.
After failure of some banks, we expect all central banks must have taken the lessons and they will be cautious to take decisions on rate hikes.
Very informative article…
Very Insightful…