Burning US economy spurs global inflation, forcing foreign banks to act

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A booming US economy pushing up inflation around the world and pushing the US dollar up is pushing some central banks to raise interest rates, despite still high levels of Covid-19 infections and incomplete economic recoveries in their own countries.

Central banks around the world are clinging to how the US Federal Reserve will react to higher inflation, fearing they will be caught in the currents of extraordinary US economic expansion. Global stock markets fell on Thursday after Fed officials signaled they expected to hike interest rates by the end of 2023, earlier than they expected in March, when the US economy is heating up.

A global march to higher interest rates, with the Fed at the center, risks stifling the economic recovery in some places, especially at a time when emerging market debt has risen.

Federal Reserve Chairman Jerome Powell described the outlook for inflation in the US economy and said there were signs that rapidly rising prices should stop rising and fall. Credit: Al Drago / Associated press

The size of the US economy, which accounts for nearly a quarter of the world’s gross domestic product, and the size of its financial markets have long exerted an outsized influence on global policy-making. But exceptionally strong US growth this year is crucial for a global economy that is still recovering from last year’s shocks. Fed officials expect the US economy to grow 7% this year, according to projections released on Wednesday.

Central banks in Russia, Brazil and Turkey have raised interest rates in recent weeks, in part to curb inflation resulting from soaring commodity prices this year. As factories around the world strive to meet American demand, prices for raw materials ranging from tin to copper have skyrocketed.

“With all the consequences of the pandemic, the last thing these countries need now is a tightening of policies,” said Tamara Basic Vasiljev, economist at Oxford Economics in London.

An American economic boom is supporting economies around the world by boosting American imports and remittances. But it also pushes up borrowing costs and inflation and strengthens the dollar, tightening global financial conditions and slowing the recovery.

The pain is felt unevenly. A stronger dollar hurts emerging market economies that have borrowed in dollars, while helping major exporters from Europe and East Asia whose products become more competitive with US exports.

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In advanced economies, central bankers mainly believe that the period of rising inflation will be temporary unless consumers expect it to continue and demand higher wages.

While central banks don’t see this happening anytime soon, some economists think they might be surprised.

“I think there is a good chance that this temporary price shock will become more lasting,” said Luigi Speranza, chief global economist at BNP Paribas. Mr Speranza noted that inflation in Germany is likely to be around 4% when the next round of wage negotiations begins towards the end of this year.

Central banks in Europe and Japan must either align with the Fed’s dovish stance or risk a spike in their currencies that could undermine the economic recovery, economists said. The tricky dance around the Fed could unravel if inflation proves to be more persistent than expected, which would likely trigger a chain reaction of interest rate hikes.

“To prevent the euro from strengthening the [European Central Bank] should be as accommodating as the Federal Reserve, which could be difficult due to the different dynamics of inflation and growth, ”said Elga Bartsch, head of macro research at BlackRock..

However, emerging market economies often do not have the luxury of waiting. Even a brief surge in inflation can take a heavy toll on their currencies and affect the ability of businesses and households to service debt, which is often denominated in dollars or euros.

The Fed has indicated that it will be careful to avoid a repeat of the 2013 “taper tantrum” in which central banks in developing countries were forced to respond to a sudden withdrawal of foreign investment after the US central bank surprised investors. investors stating that it was considering cutting back on its stimulus programs.

“Our intention for this process is therefore that it be orderly, methodical and transparent,” Federal Reserve Chairman Jerome Powell said on Wednesday. “And I can just tell you that we see real value in communicating well in advance what our thinking is. And we will try to be clear.

But with the acceleration of global inflation and the change of course of the Fed, the calculation of some central banks is changing.

Brazil’s central bank on Wednesday unveiled a third consecutive interest rate hike of 0.75 percentage points and signaled possible larger increases to come as it battles inflation above 8%.

The Bank of Russia has raised its policy rate three times this year to 5.5%, after inflation accelerated to more than 6% this month, its highest level in nearly five years. Governor Elvira Nabiullina said on Tuesday that Russia will continue to raise interest rates and does not expect this to hamper economic growth.

“We have kept rates low for a while to make sure we don’t cut the wings of a recovering economy,” Ms. Nabiullina said in a speech to the lower house of the Russian parliament. “Now is the time to raise rates in response to changing circumstances and rising inflation. “

Russian central bank governor Elvira Nabiullina presented the bank’s annual report to the Russian parliament on Tuesday.


Photo:

Sergei Fadeichev / Zuma Press

Turkey’s central bank sharply raised its main interest rate to 19% in March to counter double-digit inflation and a depreciating pound. But the Turkish lira has come under further pressure in recent weeks as investors try to assess whether the central bank will heed President Recep Tayyip Erdogan’s demands to cut rates.

Recent price increases on fresh produce have increased the so-called borscht set – the vegetables necessary for Russia’s beloved soup – which is a telltale indicator for many Russians. Since the start of the year, the prices of potatoes, cabbages and carrots have increased by 60 to 80%.

In poor countries, a larger share of spending tends to go on basic necessities such as food and energy, so policymakers are quicker to curb inflation when these prices rise.

Central banks in Scandinavia and South Korea have announced plans to tighten monetary policy to contain possible asset bubbles, especially in real estate. Norway’s central bank said on Thursday it would raise interest rates in September.

Central European central banks, including Hungary and the Czech Republic, are also expected to raise rates soon. They did not experience contractions of the same magnitude as major European countries like France and Spain during the pandemic, but are seeing inflation rise.

Iain Stealey, director of fixed income investments at JP Morgan Asset Management, said the Fed would likely manage to avoid a repeat of the “taper tantrum”.

“It’s a very long and slow process… it’s very hard not to do it given the surprises on the upside in inflation,” Stealey said.

Still, the patient approach poses problems, economists said.

“This idea of ​​letting inflation soar… means you won’t realize you have an inflation problem when you already have an inflation problem,” said Klaus Baader, chief global economist at Societe Generale.

Federal Reserve Chairman Jerome Powell described the outlook for inflation in the US economy and said there were signs that rapidly rising prices should stop rising and fall. Credit: Al Drago / Associated press

Write to Tom Fairless at [email protected] and Paul Hannon at [email protected]

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