Central banks informed to step on brakes to fight inflation: IMF warns of ‘painful’ rate of interest hikes if Iran warfare drags on

Central banks must be prepared to ‘step on the brakes’ and raise interest rates to head off rampant inflation, the International Monetary Fund (IMF) warned last night.

In an assessment that will alarm households and businesses, the financial watchdog’s top economist said policymakers may need to ‘inflict much more pain’ than they previously did to bring prices back under control after the pandemic and Russia’s invasion of Ukraine.

Pierre-Olivier Gourinchas said a prolonged war in the Middle East that sees oil prices average $110 a barrel this year and $125 in 2027 would tip many countries into recession and fuel fears that ‘inflation is here to stay’.

‘Stepping on the brakes will be painful’ in such an environment, he added.

The comments came as the IMF, led by managing director Kristalina Georgieva, downgraded its global growth forecasts and warned a global recession would be a ‘close call’ if the war with Iran drags on.

Britain was handed the biggest downgrade to its economic prospects in the G7, with growth forecasts for this year slashed by 0.5 percentage points to 0.8 per cent.

Alarm: IMF managing director Kristalina Georgieva downgraded its global growth forecasts and warned a global recession would be a ‘close call’ if the war with Iran drags on

And it is feared a fresh inflation shock caused by soaring energy and fuel prices will force the Bank of England to raise interest rates this year – hitting households and businesses even as the economy slows. 

Ahead of Donald Trump’s war on Iran and the closure of the Strait of Hormuz, there had been optimism that the Bank of England would cut rates this year from 3.75 per cent to perhaps as low as 3 per cent.

The prospect now is for higher rates which would punish business investment, hurt homebuyers and add to the cost of servicing the national debt mountain.

Gourinchas told a press conference at the IMF that the Bank, the US Federal Reserve and European Central Bank must be prepared to act.

‘We don’t necessarily think that they need to raise interest rates right away, but if they see signs that inflation is taking hold, that if they see signs that the wage-price spirals, if they see signs that households and businesses start expecting a more permanent and persistent inflation, then they will need to take action,’ he said.

He said that in 2022, after Russia invaded Ukraine, ‘central banks delivered a successful disinflation without a recession’.

‘Now there are reasons to doubt it,’ Gourinchas said, as he urged central bankers not to wait too long as they did after the pandemic.

Most of the advanced countries would have to let central banks do the heavy lifting, which could be painful, because government debt across most of the G7 is at high levels, often exceeding annual national output.

Warning against generous government intervention, Gourinchas said: ‘Fiscal space is much thinner than before. 

‘Price caps, subsidies and similar interventions are popular, but they distort prices. Most countries don’t have that luxury anymore.’