If inflation remains stubbornly high into the second half of 2022, there’s a risk that rates may go up further and faster than currently expected, raising the risk of recession, says Fitch Ratings.
In a new report, the rating agency warned that persistent inflation could start to threaten the global economic outlook this year.
As it stands, inflation is expected to subside in the second half of 2022 “as consumer goods shortages moderate, pandemic constraints on labour supply fade and growth rates normalize,” Fitch said.
This scenario should allow central banks to gradually raise rates, which would have limited effects on growth.
Fitch currently expects the U.S. Federal Reserve to raise rates by 100 basis points this year and by another 100 bps in 2023.
Similarly, the Bank of England is seen hiking rates by another 75 bps this year and 50 bps in 2023.
However, Fitch noted that recent inflation readings have been higher than expected, and that the outlook is uncertain.
“Inflation is a dynamic process and can be self-reinforcing,” it said. “Various factors could keep core inflation high throughout 2022. Global energy price shocks related to the Russia-Ukraine crisis exacerbate risks.”
If that sort of scenario materializes, the Fed could be forced to push rates up faster than planned, the report noted.
“This could entail the Fed Funds rate rising to 3% by the end of this year,” Fitch said.
A sharper rise in rates could “take a big toll on GDP” through tighter credit conditions and a sharp rise in long-term U.S. bond yields, it noted.
“U.S. GDP growth could fall to 0.5% or below in 2023 in such a scenario, compared with Fitch’s baseline forecast of 1.9%,” it said.