Breakingviews: Firefighting leaves central banks on shaky ground

A flock of hawks flew over financial markets on Thursday. Central banks in the UK, Switzerland, Norway and Turkey all raised interest rates. Sticky inflation demands aggressive action. But as economies weaken, rate-setters may come under fire from politicians. Britain’s Andrew Bailey and Turkey’s Hafize Gaye Erkan look particularly vulnerable to political attacks.

The four central banks face similar problems. Although annual inflation rates range from 2.2% in Switzerland to 39.6% in Turkey, the policymakers are all concerned about consumer prices remaining high for too long. Increasing interest rates is the only weapon they have to bring inflation back to their targets. Both the Bank of England and Norway’s Norges Bank surprised markets by hiking rates a full 50 basis points, with the UK base rate reaching 5%.

Rate-setters also share a key challenge: higher borrowing costs reduce demand and credit availability, raising the risk of recessions, especially when economies are already weak. That’s evident in the UK, where high inflation has been accompanied by flatlining GDP growth. But even in Switzerland the central bank expects output to expand by just 1% this year, while Norges Bank is projecting 1.2% growth in 2023. In Turkey the hyper-inflationary environment – the result of unorthodox policies championed by President Tayyip Erdogan – means that the newly appointed Erkan will have to oversee a huge rise in interest rates. Thursday’s 650-basis-point rise to 15% disappointed investors who were expecting rates to reach 20%.

Politics adds a particular challenge for Bailey, and Erkan. In Britain, a spike in mortgage rates is dragging down the Conservative government’s popularity ahead of an election expected in late 2024. And, with annual inflation stuck at 8.7% in May, Prime Minister Rishi Sunak may miss his pledge of halving consumer prices’ growth from 10% to 5% by the end of 2023. Sunak’s problem is that his own party’s policies have exacerbated the inflation crisis, not least its decision to push through a violent break with the European Union, which created a labour shortage. In Turkey, meanwhile, Erdogan’s fine political antennae and unpredictable nature mean that he may lose patience with the central bank’s recent shift towards mainstream economic thinking, especially if popular sentiment turns.

In both Turkey and Britain, the risk for central bankers is that they are tagged with economic failures by politicians keen to deflect voters’ anger. Bailey and Erkan are right in prescribing harsh medicine to cure their economies’ ills. But they need to be aware that politicians are likely to reject those bitter pills and blame the doctors instead.