17th April 2023

The balancing act being performed by central banks between taming inflation and avoiding recession got even harder in March as a new fault line emerged in the banking sector.  The crises at Silicon Valley Bank and Credit Suisse were idiosyncratic and largely self-inflicted – the former had been without a Chief Risk Officer for most of 2022 whilst pursuing a highly risky investment strategy and the latter had lurched from one well-publicised disaster or scandal to another in recent years.  Bank runs occur when depositors lose confidence that their money is safe.  However, the banking system as a whole is substantially more robust than it was before 2008’s financial crisis.

Thanks to a mild winter and tumbling gas prices, easing of supply chain pressures and year-on-year base effects, we expect headline rates of inflation to continue to decline.  Despite February’s unexpected blip, Prime Minister Sunak’s pledge to halve the inflation rate by the end of 2023 is still very achievable.  ‘Core’ inflation, though, which excludes energy and food, is proving much stickier.  In the US, the headline inflation rate has dropped from a peak of 9.1% in June last year to 6.0% but core inflation has fallen only from 5.9% to 5.5%.

This is in no small part because labour markets, consumer spending and economic growth have so far remained surprisingly resilient even as interest rates have soared from 0.1% to 4.25% in the UK and from 0.25% to 5% in the US in little more than a year.  Unemployment rates continue to be close to 50-year lows in both the UK and the US.  Wage growth, though, in real (after inflation) terms is currently still negative and this is prolonging the cost-of-living squeeze.

It is almost inevitable that there will be further casualties as a result of the abrupt withdrawal of the punchbowl of abundant and ultra-cheap debt from which governments, companies and investors had been binging for more than a decade.  We can only speculate as to where the next fracture might occur, but central banks might be forced to put financial and economic stability first and let up in their fight to crush inflation.  “