The Fed’s resolute course is also likely to increase pressure on the European Central Bank (ECB) to change course in the fight against inflation. “The Fed is moving boldly,” commented the chief economist of the VP Bank Group in Liechtenstein, Thomas Gitzel. “The ECB should now take over and make it clear that several interest rate hikes are to be expected in the current year,” he wrote. With its clear communication, the Fed reinforces its credibility, “the ECB, on the other hand, the pledge”, he writes. Targobank’s chief economist, Otmar Lang, said, referring to ECB boss Christine Lagarde, that the ECB should take the Fed as an example: “Ms. Lagarde, that’s how it works!”
European currency holders have already moved to phase out their multi-billion dollar bond purchases more quickly. Moreover, several members of the ECB’s Governing Council have recently suggested an initial interest rate hike in July. Financial markets expect the ECB to raise the deposit rate, at which banks can place money with it, from minus 0.5% to zero percent this year. The key interest rate, which has been at a historically low level of zero percent for more than six years, could then be raised in 2023.
Inflation in the euro zone hit a record high of 7.5% in April. In the United States, the largest economy in the world, the inflation rate was 8.5% compared to the same month last year.
For many months, the US inflation rate has been well above the central bank’s medium-term target of 2%. Now the central bank is taking countermeasures: with its interest rate hikes, the Fed wants to make loans more expensive quickly in order to slow aggregate demand. This helps lower the rate of inflation, but also weakens economic growth. It is therefore a dangerous balancing act for the central bank: it wants to raise interest rates so quickly and so much that inflation is slowed down – but without paralyzing the economy and the labor market at the same time.
Powell said the goal was to use central bank tools to align supply and demand and bring down inflation. The economy should cool in a way that will not lead to a recession. “I expect it to be a big challenge,” Powell said. “It won’t be easy.” However, there are currently so many vacancies in the job market that even a slight downturn in the economy is unlikely to increase unemployment, Powell said.
Following the hike announced on Wednesday, the base rate is now between 0.75 and 1%. This was the second interest rate increase since the start of the corona pandemic – and the first increase of 0.5 percentage points in 22 years. As a general rule, the Fed prefers to raise interest rates in increments of 0.25 percentage points. The decision was widely expected by the markets.
When asked, Powell said that even more drastic interest rate hikes of around 0.75 percentage points should not be expected at this time – a comment that was met with relief in financial markets. .
The consequences of Russia’s war of aggression in Ukraine, for example in view of rising energy and food prices, are increasing inflationary pressure and are likely to weigh on the economy, Powell explained. Corona shutdowns in China are also likely to cause further disruptions in global supply chains, which could affect inflation and growth.
Mortgage funding costs in the United States, for example, have already increased significantly due to the Fed’s monetary policy tightening. Critics, however, accuse the most powerful central bank of having reacted too late to the rise in prices. In his opinion, the central bank should have stopped its support programs for the Corona crisis economy and raised interest rates in the second half of last year. The Fed had largely described inflation in 2021 as a “temporary” phenomenon.
A challenge for the Fed is that it can only influence some of the causes of price increases to a limited extent. Disruptions to global supply chains and rising energy prices do not react directly to US interest rates. The Fed is also unable to control the consequences of the war in Ukraine and the corona shutdowns in China.
Analysts therefore expect further rate hikes this year. According to observers, the key rate could be equal to or higher than 2% by the end of the year. The Fed also wants to rapidly reduce its balance sheet, which has swelled to around nine trillion US dollars following the Corona emergency programs. Starting in June, a total of $47.5 billion in assets that expire each month will not be rolled over, the central bank said. By September, the monthly total is expected to reach $95 billion. This will remove more liquidity from the markets.
The Fed is committed to the objectives of price stability and full employment. The US economy is booming again, with the unemployment rate recently dropping to 3.6%. Many employers are already complaining about not finding enough candidates for their vacancies.
The Central Bank Council meets approximately every six weeks to decide on the direction of monetary policy. The next session will end on June 15. Given the high inflation rate, the Fed stopped buying securities worth billions in March and raised its key rate by 0.25 percentage points for the first time since the Corona crisis.
Editing finanzen.net / dpa-AFX
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