Guru who foresaw 2008 financial crisis puts UK on red alert

The markets guru who was credited with predicting the 2008 financial crash has warned that Britain faces rampant inflation if businesses keep getting hammered by lockdowns. 

Raghuram Rajan, former governor of the Reserve Bank of India and onetime chief economist at the International Monetary Fund, said businesses could keep raising prices if they face heavy costs from repeated lockdowns, and find they can successfully pass on those costs to consumers. 

He said central banks would be watching prices closely in the next year and could be forced to raise interest rates rapidly if they felt inflation would spiral out of control. 

And he warned of a stock market sell-off if fund managers realised they no longer needed to plough money into higher-risk investments to generate a decent return. 

Rajan’s red alert to the UK comes as speculation persists about the return of some lockdown restrictions in the autumn or winter, as Covid cases may rise again in the cold weather. 

The world-renowned economist famously warned about a ‘catastrophic meltdown’ in global markets when he was chief economist at the IMF in 2005. He was mocked by US policymakers at the time, but his analysis proved correct – and he is now considered a leading thinker on the economy. 

He was widely touted as a top candidate to replace Mark Carney as Governor of the Bank of England in 2019, but later said he did not apply for the position, which ultimately went to Andrew Bailey, then the boss of the Financial Conduct Authority – the City watchdog. 

Rajan told The Mail on Sunday that companies could easily get hooked on a cycle of price increases if they were not allowed to recover fully from the pandemic.

He said global economies would face ‘persistent’ inflation if workers then used those higher prices to negotiate better pay, which would stoke prices still further. 

He said: ‘Companies haven’t felt comfortable raising their prices for a while, and we have had some transient price increases.

‘But those could become persistent if the transition [out of the pandemic] is long enough. 

‘We are seeing global supply chains backing up due to the back-and-forth of the pandemic. Different parts of the world are being hit at different times. These backlogs mean businesses spend three times as much on orders to ensure they are not caught out. Businesses will then raise prices if there is a fair amount of demand out there and it isn’t quelled by rising prices.’ 

Rajan warns: ‘It starts to get worrisome if companies are confident they can raise prices and make it stick. And then workers see everything is moving up and they say, ‘Hey, why aren’t my wages moving up?’ And they go to their bosses to ask for a wage increase. And that’s what the monetary authorities are fearful of.’ He said the Government could help keep costs low for firms by being more upfront about the circumstances under which it would reimpose a lockdown. 

He said: ‘You just have to be as transparent as possible on what the decision-making process is and maybe try and set some parameters.’ And he said of Ministers: ‘If they set some rules about when they will implement lockdowns and so on, they won’t unnecessarily upset local business and global tourism. 

‘For example, you could say you will not impose a lockdown unless cases rise above a certain level.’ 

Rajan said central banks across the world were likely to start winding down their money-printing programmes soon to clear the way for interest rate rises in 2023. 

But he warned that rates might not creep up slowly, as they did after the financial crash. He said: ‘It is too early to say how fast they will raise rates, but I don’t think they will be able to take the sort of measured pace they took before. 

‘They will probably do more this time, especially if inflation is picking up strongly. They might want to move quite quickly and take it from there. But it all depends on what the environment looks like in a year from now.’ He said a change in gear from the Bank of England could trigger a fall in stock prices. Investors would no longer need to hold risky assets to generate a decent return if rate rises were on the horizon.

If they believed that central banks would increase rates to keep inflation in check, then they could dump risky stocks and plough money into safer assets, such as bonds. 

But Rajan pointed out that US bond rates are still at historically low levels, suggesting investors had not diverted funds into these safe haven assets just yet. 

‘My sense is that money managers still believe that rates will stay low for a long time and are still searching for yield,’ he said.

‘So, there will be some adjustment and whether that will be devastating is anyone’s guess. It might happen in some areas [of the stock market] more than others.

‘You will see it happen as soon as monetary authorities are serious about changing the interest rate environment.’