(Bloomberg) — The European Central Bank and the Bank of England must keep raising interest rates to ward off “stagflation,” the prominent economist Nouriel Roubini warned.
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The famously pessimistic Roubini said the recent rise in oil prices will keep headline inflation high and that any talk of easier monetary policy is premature. The ECB and BOE face a bigger dilemma than the US Federal Reserve because prices in Europe are still rising fast and growth is slowing, he said.
The BOE “should be hiking rates all the way to 5.75%,” Roubini said Monday in an interview on Bloomberg Television. The UK central bank’s key rate is currently 5.25%, and a further quarter point rise is expected this week.
Roubini, professor of economics and international business at New York University’s Stern School of Business, is famous for bearish pronouncements that earned him the moniker “Dr Doom.” However, he correctly warned of disaster before the 2008 financial crisis and is followed for his often counter-conventional views.
On Monday, he recommended shorting US stocks for the rest of the year and said investors are too optimistic on credit and bond markets. A 10% decline in US equities is possible given the state of the global economy, he warned, adding that other stock markets would fare even worse.
Eurozone and UK central banks are in a bind because inflation is too high and economies are faltering, but he said they need to keep raising rates to beat inflation.
“That’s a dilemma for both the ECB and the BOE,” Roubini said. “On one side, the contracting economic activity will lead them to maybe stop at this point. On the other, if inflation remains much higher than the target, they may need to a hike much more.”
The US is in a stronger position, with “good news” pointing to no “hard landing” for the economy. But he said markets are wrong to expect rate cuts early next year. Instead, he said the Fed may still need to raise rates further and the first cuts will happen “maybe towards the middle of the year (2024).”
“They can’t say they are done. Headline inflation is going higher, oil prices going higher, there is potential there will be another hike.” The Fed is expected to hold rates at 5.25%-5.5% this week.
Recent dovish signals from the BOE are a “problem.” “The signals are telling us they’re not sure whether they want to hike more,” he said. Without further rate increases, “there could be a de-anchoring of inflation and true stagflation,” he warned.
The BOE changed its guidance as the economy has started to slow. Output fell in July and unemployment is rising. UK policymakers are talking about rates staying high for longer, rather than pushing through more increases to tame prices. Consumer price inflation is currently 6.8% — more than three times the 2% target.
Official figures this week are expected to show UK inflation rose to 7.1% in August due to rising oil prices, complicating the BOE’s decision on Thursday. The ECB raised rates a quarter point to 4% last week and indicated its rate rise cycle was near an end.
Although Roubini believes higher rates are required, he said they threaten to create their own problems.
Referring to the pension crisis in the UK a year ago and the regional banking blow up in the US earlier this year, he said: “There are risks of financial instability. You saw it in what happened in the UK about a year ago, you saw what happened in the spring of this year with the stresses in the financial system. I don’t think we’re out of the woods as rates have to stay higher for longer. The possibility of some degree of financial instability is still with us.”
Structural changes to the global economy – from ageing demographics to supply chain geopolitics — will keep inflation high, he added. As a result central banks will over time have to raise their inflation target from 2% to 3% or 4%, he said.
“Both on the supply side and the demand side, there are factors implying that 2% is at this point mission impossible. And the new normal may be somewhere between 3% and 4% for advanced economies over time, of course not overnight,” he said.
–With assistance from Dani Burger and Manus Cranny.
(Updates with comments from interview.)
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