As expected, the US Fed has raised interest rates again. This time 0.5%. The Bank of England is likely to raise them this Thursday as well, the fourth consecutive increase. Monetary and financial events —including the recent stock market crash— are precipitated by the agglomeration of supply and demand problems. The disparate reaction of central banks to inflation is already having a significant effect on currency markets, on exchange rates, with a notable appreciation of the dollar against the euro and the pound sterling. This exchange rate instability adds to the abundant uncertainty and volatility that exists. In the Eurozone, we are still waiting for more details on what the ECB will do in the coming months.
With an increasingly complicated global trade —after the pandemic, the war in Ukraine and the accompanying sanctions—, the main problems initially came from an insufficient supply capacity in the face of a reactivated demand after the covid, which led to an increase in the price of the energy, transportation and raw materials, followed by almost all other goods and services. These supply problems and higher costs of essential products could feed back in the coming weeks due to the stoppage in China, with confinements in important industrial cities. The Asian giant’s strategy in the face of the pandemic (covid-zero) will continue to generate headaches in global value chains and, therefore, in supply. Also the uncertainties about gas and oil, in particular for Europe, the most affected.
The macroeconomic data of the last week, with the disappointing GDP for the first quarter in the Eurozone and negative in the United States, seem to reflect a greater weakening in demand than expected, especially in consumption, given the loss of purchasing power of the families with inflation. This has not stopped the Fed from raising rates. The US labor market shows strength and full employment. However, if demand stagnates or weakens further—something that higher rates may help—the monetary policy dilemmas will become more apparent. How to fight inflation with insufficient supply and weak demand? What a landscape.
Prioritizing the problems, it seems inevitable in the coming months to combat inflation with all the instruments to avoid greater second-round effects and medium-term difficulties. It requires increases in the cost of money, among other economic policy actions, that bring real rates closer to positive territory. That is what the Fed and the Bank of England have done. The ECB should join soon, although it appears to be behind the curve. This disparate evolution of official rates and the greater impact of the war on the economy of the Old Continent is making the dollar more expensive compared to the euro. The energy bill paid with the US currency will increase, although it will be offset somewhat by the gain in competitiveness of eurozone exports. In the coming months, the evolution of the different interest and exchange rates will say a lot about what happens in the global economy.
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