Inflation Fears Could Trigger Central Banks to Change Policies

21 Jun 2021 · 3rd Party Analysis


In Summary

  • Global markets threatened by higher inflation pressures
  • Central banks hang on how the US Federal Reserve will handle the spike in prices

Concerns are rising that higher inflation expectations could propel central banks across the world to respond by changing their monetary policies. Amid a largely uneven global economic recovery and areas with still-high levels of Covid-19 cases, the booming US economy has driven inflation higher around the global markets.

Central bankers in Europe and Asia are closely monitoring how the Federal Reserve will act to curb a sharp rise in inflation on the back of the increased monetary support that has injected trillions of dollars into the US economy since the start of the pandemic in March last year.

Fed’s policies to keep the interest rate at ultra-low levels and to bolster the economy with monthly injections of $120bn in asset purchases have brought the stock market to new all-time records but not without significant risks. The extraordinary pace of economic expansion in the US was last seen in the early 1980s. The economic recovery, however, now hangs on the next tricky step of the Fed.

Global stock markets started falling on Wednesday after the Federal Open Market Committee signaled it expects to raise interest rates by late 2023. Some Fed officials anticipate an even quicker interest rate increase as soon as next year.

The red-hot US economy with the Fed at the center is stoking fears among world’s central banks that the recovery of their economies could be derailed if inflation spreads and continues to rise. A global march toward higher interest rateс could follow. If materialized, it has the potential to stifle growth.

Financial Heat Raising Worldwide

Higher prices are already present in the eurozone. According to the latest consumer price report, inflation in the euro area rose to 2% in May, surpassing ECB’s inflation target of just below 2%. ECB officials downplayed the figures saying inflation pressures would be temporary.

Central banks in Russia, Brazil and Turkey have already raised interest rates in recent months in efforts to anticipate and prevent higher inflation to hit their economies and their ability to compete in the global markets. While a booming US economy means markets around the world could benefit from increased imports to the US, it also drives the dollar higher and raises borrowing costs.

A stronger dollar is particularly damaging to emerging-market economies that have borrowed in dollars, meaning the value of their debt will keep rising with the pace of the appreciation of the greenback. On the other hand, an expensive dollar helps exporters in Europe and Asia to produce more competitive products relative to US exports.

A spike in inflation pressures is widely expected to fade as the global economic recovery continues. Central bankers in the Federal Reserve, similar to those at the European Central Bank, believe higher prices will prove to be a temporary event. If inflation turns out to be more persistent than expected, it could likely trigger a wave of interest-rate increases combined with policy tightening that will aim to reduce the amount of money flowing in the system.

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