IMF's Gita Gopinath warns economies will need to adapt to higher global interest rates

Gita Gopinath was the IMF's Chief Economist until she took charge as its First Deputy Managing Director on January 21.

Gita Gopinath has warned monetary policy is at a "critical juncture" in most countries and that economies will need to adapt to higher interest rates globally.

"Where inflation is broad-based alongside a strong recovery, like in the United States, or high inflation runs the risk of becoming entrenched, as in some emerging market and developing economies and advanced economies, extraordinary monetary policy support should be withdrawn," Gopinath wrote in an article accompanying the IMF's update to its World Economic Outlook report, released on January 25.

Gopinath was the IMF's Chief Economist until she took charge as its First Deputy Managing Director on January 21.

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In its update to the World Economic Outlook report, the IMF said it expects elevated inflation to persist for longer than was anticipated in October 2021. As such, consumer prices in advanced economies are now seen 3.9 percent higher in 2022, up 160 basis points from what was forecast in October 2021. Similarly, consumer prices in emerging markets and developing economies are seen 5.9 percent higher this calendar year. In October 2021, the IMF had forecast an increase of 4.9 percent.

Gopinath's warning comes ahead of a key meeting of the US Federal Reserve's Federal Open Market Committee. With inflation in the United States running at multi-decade highs, the central bank is seen raising the federal funds rate target range multiple times in 2022. While an interest rate hike is not the expected outcome of the January 25-26 meeting of the Federal Open Market Committee, the CME's FedWatch Tool has placed a 31.4 percent probability on the federal funds rate target range ending 2022 at 1.00-1.25 percent. This implies four rate hikes of 25 basis points each.

The federal funds rate target range is currently 0.00-0.25 percent.

Gopinath warned higher inflation surprises in the United States could result in "aggressive monetary tightening" by the Federal Reserve, which could, in turn, lead to sharply tighter global financial conditions.

"Several central banks have already begun raising interest rates to get ahead of price pressures. It is key to communicate well the policy transition towards a tightening stance to ensure orderly market reaction. Where core inflationary pressures remain subdued, and recoveries incomplete, monetary policy can remain accommodative," she added.

In India, the Reserve Bank of India's Monetary Policy Committee has been guiding for policy rates staying at their current record low levels for longer. However, bond yields have been rising sharply and are at the highest in two years.