"WB's Warning: If Interest Rates Rise Too Much, Economic Recession Next Year; Fed's Dilemma"

[Asia Economy New York=Special Correspondent Joselgina, Sejong=Reporter Kwon Haeyoung] The World Bank (WB) has issued a warning that the series of interest rate hikes by major central banks, including the U.S. Federal Reserve (Fed), will push the global economy into a recession phase next year. With monetary tightening policies aimed at curbing soaring inflation expected to continue through next year, the WB’s sober assessment is that even the inflation control effects of these measures are uncertain.

Despite two consecutive giant steps (0.75 percentage point interest rate hikes), the Fed’s dilemma has deepened as it has neither seen significant policy effects nor confirmed the peak of inflation. South Korea, which is highly affected by economic impacts due to external uncertainties, is in the same situation.

◇WB: "Global Economy Nearing Recession Phase"

In a research report released on the 15th (local time), the WB stated, "As central banks worldwide simultaneously raise interest rates in response to inflation, the global economy is heading toward a recession in 2023."

According to the report, central banks around the world have raised interest rates simultaneously at a scale unseen in the past 50 years since the beginning of this year, and this trend is expected to continue through next year. The Fed, which entered a tightening cycle in March and has raised its benchmark interest rate by a total of 2.25 percentage points, is a representative example. However, despite this simultaneous high-intensity tightening, inflation shows no signs of being controlled, and instability in global financial markets is worsening.

The report warned, "The currently expected interest rate hikes and other policy measures may not be sufficient to reduce global inflation to pre-pandemic levels." Unless supply chain disruptions and labor market pressures, which are the underlying causes of inflation, normalize, global core inflation in 2023 is estimated to be around 5%. This is about twice the average of the five years before the pandemic.

Furthermore, through simulations, the report predicted that central banks worldwide would need to raise interest rates by an additional 2 percentage points from the current level to bring global inflation down to target levels. When factoring in market instability, the global gross domestic product (GDP) growth rate in 2023 is analyzed to slow by 0.5%, or 0.4% per capita, meeting the technical definition of a global recession. David Malpass, President of the WB, expressed concern, saying, "More countries may enter recession and slow down further. This will have particularly devastating consequences for emerging and developing countries."

◇Fed and Bank of Korea Face Deepening Dilemmas

This warning has drawn more attention as it was released ahead of the Fed’s September Federal Open Market Committee (FOMC) meeting scheduled for the 20th-21st. This is because, following the August U.S. Consumer Price Index (CPI) release that exceeded expectations, at least a 0.75 percentage point hike is anticipated. According to the Chicago Mercantile Exchange (CME) Group’s FedWatch, the current interest rate futures market reflects over a 76% probability of a giant step this month. The possibility of a 1 percentage point hike is also as high as 24%.

The Washington Post (WP) reported, "Fed Chair Jerome Powell strongly indicated in his Jackson Hole speech last month that inflation is the top priority and that high-intensity tightening will continue," adding, "This Fed resolve was likely reinforced by the August CPI that exceeded expectations."

Reports have also emerged that the Fed is facing internal divisions over its next move. Economic media CNBC pointed out, "If interest rates are raised too little, the Fed may lose control over inflation," while "If raised too much, the economy risks falling into a prolonged recession." The Fed’s dilemma has grown larger as it tries to control inflation while avoiding recession risks at a time when the neutral interest rate has already been reached. Concerns that excessive tightening could cause an unnecessary recession were also confirmed in the July FOMC minutes.

Voices expressing concern over the repercussions of the recently rapidly emerging 1 percentage point hike option are also increasing. Bloomberg News diagnosed, "A 1 percentage point hike could send a message that the Fed is in an inflation panic, causing turmoil in credit and financial markets," adding, "Aggressive rate hikes increase financing costs for real estate and other sectors, leading to inflationary pressures such as rising housing costs."

The Bank of Korea’s dilemma is also deepening. Although it cannot avoid considering a big step (0.5 percentage point interest rate hike) in response to U.S. rate hikes, exchange rate defense, and high inflation, signs of economic slowdown are becoming more pronounced. The government’s warning of economic slowdown concerns for four consecutive months is also inevitably a burden for the Bank of Korea. The Ministry of Economy and Finance released the ‘Recent Economic Trends September Issue (Green Book)’ on the same day, stating, "High levels of inflation persist due to external factors," and "Economic sentiment is partly affected, raising concerns about economic slowdown such as weakening export recovery."

With global economic contraction making exports difficult and downside risks to the economy increasing, if the Bank of Korea implements a big step, domestic economic slowdown could accelerate. Professor Kim Young-ik of Sogang University Graduate School of Economics said, "Economic growth is expected to turn negative from the fourth quarter, and a severe recession is anticipated in the first half of next year," adding, "Rather than strictly following the U.S., monetary policy suited to our economic conditions is necessary." The Bank of Korea’s Monetary Policy Committee will meet on October 12.

This content was produced with the assistance of AI translation services.