The US Federal Reserve has raised interest rates six times this year – four of them in unusually large steps. At least that could soon be the end of it. But anyone who thinks that the Fed will soon abandon its strict monetary policy is wrong.
The Fed continues its aggressive fight against inflation with another above-average rate hike – but promises a slower pace. The central bank of the world’s largest economy raised the key interest rate by 0.75 points for the fourth time in a row on Wednesday (local time). “It will be appropriate to slow the pace of hikes,” announced Fed Chair Jerome Powell. However, it would be too hasty to speak of a departure from the US Federal Reserve’s strict monetary policy.
It was the penultimate Fed meeting of the year – central bankers will meet again in December. Powell left no doubt that interest rates will rise more than the Fed previously expected. It was “premature” to pause in the hikes. “We continue to believe that continuous increases will be appropriate,” he said. A smaller interest rate step is possible as early as December – but the Fed boss did not want to commit to it.
The Fed is strengthening the US dollar with its strict monetary policy. The high interest rates make the US market more attractive for investors. The US dollar has strengthened significantly against the euro in recent months. After the latest Fed decision, the euro initially rose. However, after Powell made it clear that there was no end in sight to the rate hikes, he fell again. A weak euro makes trips to the USA significantly more expensive for tourists from the euro area. Imports from the US that are billed in dollars also cost more. For Germany as an export nation, however, a weak euro also has advantages, because exports to the USA are becoming cheaper.
US interest rate policy can trigger a serious economic crisis in low-income countries. The tight monetary policy is felt particularly in those countries that got heavily in debt during the pandemic and took out their loans in US dollars – but do not earn any dollars themselves. The higher interest rates make these loans more expensive. Imports are also becoming more expensive. All of this could have serious consequences for these countries – but also worldwide. “An expanding debt crisis in these economies would severely impact global growth and could trigger a global recession,” the International Monetary Fund (IMF) recently warned in its economic forecast.
The Fed has set a rapid pace with its unusually large rate hikes. After much hesitation, the European Central Bank (ECB) initiated a turnaround towards higher interest rates in July. It is now trying to get inflation under control by raising interest rates sharply and recently raised the key interest rate by 0.75 percentage points to 2.0 percent. Other central banks are also tightening interest rates. The British central bank is expected to raise interest rates by 0.75 points to 3 percent on Thursday.
It may well be a while before the interest rate policy of the central banks bears fruit and successes in the fight against inflation become apparent. In October, the inflation rate in the euro zone reached a record 10.7 percent. Consumer prices in the US also remain stubbornly high. According to the latest data, the inflation rate fell only slightly in September. Compared to the same month last year, consumer prices rose by 8.2 percent in September. In August, the inflation rate was 8.3 percent. “We have an imbalance between supply and demand,” said Fed Chair Powell.
The big question is whether the Fed and other central banks are overdoing it. There is a growing risk that the Fed will slow down the US economy so severely that the job market and economy will stall. A so-called “soft landing”, i.e. getting out of the situation without major upheavals, is becoming increasingly difficult, admitted Fed Chairman Powell. Still, he defended the tight monetary policy against criticism: “I’m glad we moved so quickly and I don’t think we tightened too much.”
Unlike in Europe, rising wages are also driving inflation in the USA. When the job market heats up, the pressure on the Fed to raise rates further increases. Many US companies are complaining about a labor shortage. “Job losses could be smaller (…) because the number of vacancies is so high and the labor market is so strong,” Powell emphasized, now with a view to the question of a feared economic downturn. He also made it clear that he has not yet seen a wage-price spiral.
For US President Joe Biden and his Democrats, high inflation is just as much of a problem as the fear of an economic downturn. The high prices are blamed on the US President and his party. In the midterm elections next week, the Democrats are threatened with losing their already narrow majority in the US Congress. Surveys show that inflation and the state of the economy are the top concerns for people in the country.