Understand how the United States “exports” inflation to other countries

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The Federal Reserve is focused on containing price increases in the United States.

But countries thousands of miles away are reeling from their hard-fought campaign to curb inflation, as their central banks are forced to raise interest rates faster and faster and a runaway dollar pushes down the value of their currencies. .

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“We’re seeing the Fed being as aggressive as it has been since the early 1980s. They are willing to tolerate higher unemployment and a recession,” said Chris Turner, ING’s global head of markets.

“This is not good for international growth.”

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The Federal Reserve’s decision to raise rates by three-quarters of a percentage point in three consecutive meetings, while signaling that higher rates are on the way, has prompted peers around the world to tighten up as well.

If they lag far behind the Fed, investors could pull money out of their financial markets, causing serious disruptions.

The central banks of Switzerland, the United Kingdom, Norway, Indonesia, South Africa, Taiwan, Nigeria and the Philippines followed the Fed in raising rates last week.

The Fed’s stance also pushed the dollar to two-decade highs against a basket of major currencies.

While this is helpful for Americans looking to shop abroad, it is very bad news for other countries as the value of the yuan, yen, rupee, euro and pound drops, making it more expensive to import essentials like food. and fuel.

This dynamic – in which the Fed essentially exports inflation – puts pressure on local central banks.

“The dollar does not strengthen in isolation. It has to fortify itself against something,” said James Ashley, head of international market strategy at Goldman Sachs Asset Management.

The punitive consequences of the dollar’s rapid appreciation have become clearer in recent days.

Japan intervened last Thursday for the first time in 24 years to bolster the yen, which has fallen 26% against the dollar year-to-date.

The Bank of Japan remained an exception among major central banks and resisted rate hikes despite a rise in inflation.

China is watching currency markets after the yuan’s onshore trades fell to their lowest level against the dollar since the global financial crisis, while European Central Bank President Christine Lagarde warned on Monday. ) that the strong depreciation of the euro “increased the accumulation of inflationary pressures. ”

The UK shows how quickly the situation can spiral out of control as global investors choke on a new government’s economic growth plan.

The pound sterling tumbled to a record low against the dollar on Monday after the unorthodox experiment of implementing big tax cuts while boosting borrowing set off alarm bells.

The ensuing chaos forced the Bank of England to announce an emergency bond-buying program to try to stabilize markets and prompted a warning from the International Monetary Fund (IMF), which said the UK government should reconsider its proposals.

The global financial system is “like a pressure cooker” right now, Turner said. “You need to have strong and credible policies, and any policy mistakes are punished.”

The threat to emerging markets

The World Bank recently warned that the risk of a global recession in 2023 has increased as central banks around the world raise interest rates at the same time in response to inflation.

He also said the trend could result in a series of financial crises among developing economies – many still reeling from the pandemic – “that would cause them lasting damage”.

The greatest consequences can be felt in countries that have issued dollar-denominated debt.

Paying those obligations becomes more expensive as local currencies weaken, forcing governments to cut spending in other areas as inflation ravages living standards.

The dwindling currency reserves are also a cause for concern.

The shortage of dollars in Sri Lanka contributed to the worst economic crisis in the country’s history and forced its president to step down earlier this year.

The risks are revealed by the size of interest rate increases in many of these countries.

Brazil, for example, kept interest rates stable this month, but only after 12 consecutive hikes that left its base rate at 13.75%.

Nigeria’s central bank raised rates to 15.5% on Tuesday, far above what economists had expected.

In a statement, the central bank noted that “continued monetary policy tightening by the US Federal Reserve is also putting pressure on local currencies around the world, with a pass-through to domestic prices.”

Can the pain be stopped?

The last time the dollar suffered a similar decline, in the early 1980s, policymakers in the United States, Japan, Germany, France and the United Kingdom announced a coordinated intervention in currency markets that became known as the Plaza Accord.

The dollar’s recent rally, and the resulting pain it has caused other countries, has sparked rumors that it may be time for another deal.

But the White House has thrown cold water on the idea, making it unlikely for now.

“I don’t anticipate that’s where we’re going,” Brian Deese, director of the National Economic Council, said Tuesday.

In the meantime, the Federal Reserve is expected to stay the course. This means that the dollar can still rise further and other central banks will not be able to relax.

The dollar’s added strength and higher US rates are “absolutely something we should look forward to, and the consequences of that are really very profound,” said Ashley of Goldman Sachs Asset Management.

Source: CNN Brasil

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