The OECD defends interest rate hikes, but warns of its impact on growth and banks

Organization for Economic Cooperation and Development (OECD) lowered the government’s growth expectations for the Spanish economy this Friday.

Although the agency estimates that the gross domestic product (GDP) will advance by 1.7%, three tenths more than what was calculated last November, a figure still almost half a point short of the Sánchez Executive’s projections (2.1%). Nevertheless, the one from Brussels is improving, which limits the growth of the Spanish economy to 1.4% this year. This is the best data among the large economies of the eurozone. France will struggle to advance 0.7%; Italy 0.6% and Germany only 0.3%, flirting with stagnation.

Inflation in the spotlight

Why this more optimistic review? to what inflation in Spain it is calming down – according to the organization it will end the year at 4.2% – largely thanks to the reduction in energy prices and despite the fact that food is still growing. In neighboring countries, prices are reluctant to drop. The OECD calculates that inflation in Germany in 2023 will be 6.7%; 5.5% in France and 6.7% in Italy. However, the organization estimates that in 2024 the rate will stabilize in Spain at 4%, much higher than the 2.5% in Italy and France or the 3.1% in Germany.

One of the factors influencing this slow decrease is a particularly significant (and worrying) recovery in core inflation in Spain, which excludes the most volatile energy and fresh food prices, which will go from 3.8% in 2022 to 5% this year, according to Efe. It will reduce its growth to 3.7% in 2024, a threshold much higher than the average for the euro area (3%), as well as the average for Germany (3.1%), France (2.3%) and Italy (2. 9%).

“Additional interest rate hikes are still needed”

With this scenario, the organization supported the European Central Bank’s decision this Friday (ECB) raise interest rates by half a point, up to the reference 3.5%. “Monetary policy should remain restrictive until there are clear signs that underlying inflationary pressures have been permanently reduced,” he points out, reports Europa Press.

It’s more. The OECD believes that in both the United States and the euro area “further increases in interest rates remain necessary”, which is why it considers it likely that official rates, given the slow decline in core inflation, will remain high until. deep into 2024, meaning increasing pressure on mortgage borrowers and businesses.

The cost: lower growth and banking turmoil

In turn, the body admits that the rise in interest rates it will harm economic growth by limiting and increasing the cost of credit and could cause banking problems like those seen last week.

The threat of inflation becoming chronic could force central banks to hold interest rates higher than banks expect, causing financial panic. “Increased stress for households and companies and the increased possibility of non-payment of loans increase the risks of potential losses in banks and non-bank financial institutions”notes the OECD.

For an institution, sudden changes in market interest rates and the current market value of bond portfolios could also further expose duration risks to financial institutions’ business models, as evidenced by the bankruptcy of the US bank. Silicon Valley Bank.

In this sense, he believes that immediate actions to protect depositors, while punishing shareholders, and improved regulation after the global financial crisis “reduce the risk of widespread financial contagion.”

“Signs of the impact of tighter monetary policy have begun to emerge in parts of the banking sector, including banks in the United States,” says the OECD, which also points out that real and expected credit growth has slowed in several economies, including the eurozone.