Central banks accept big raises to support currencies and fight inflation

A string of massive rate hikes by the Federal Reserve has forced central banks around the world to follow suit to counter soaring inflation and a strong dollar.

An analysis by the Financial Times showed that central banks now more than at any time in this century are opting for massive rate hikes of 50 basis points or more, exposing the challenges of coping with price pressures and higher rates in the US.

The rise of the Fed, including its first 75 basis point hike since 1994, and concerns about the health of the global economy have strengthened the US dollar against almost all currencies. Since many goods on international markets are priced in dollars, a strong dollar adds to inflationary pressures by raising the cost of imports, creating what analysts have called a “reverse currency war” between monetary policy makers.

“We are seeing a frenzy fueling rate hikes,” said James Athey, senior portfolio manager at investment firm Abrdn. “This is the opposite of what we have seen in the last decade. . . At present, the last thing anyone needs is a weak currency.”

Canadian politicians were the latest to surprise markets with a bigger-than-expected gain, opting for a 100 basis point gain on Wednesday, the most for any G7 economy since 1998. The next day, the Philippines raised rates by 75 basis points.

In the three months to June, 55 central banks tracked by the Financial Times raised their policy rates by at least 50 basis points 62 times. Another 17 large increases of 50 basis points or more were made in July, marking the most large rate changes at any time since the turn of the millennium and eclipsing the most recent global monetary tightening cycle that was in full swing. until the global financial crisis.

“We have seen this pivot point in the market where 50 is the new 25,” said Jane Foley, head of FX strategy at Rabobank.

Central banks in countries under severe currency pressure have raised rates by particularly large amounts. Hungary stands out, with its key rate up 385 basis points in just two months as the country grapples with double-digit inflation and currency depreciation against the dollar.

The exchange rate component plays an important role in monetary policy decisions for many emerging markets, said Jennifer McKeown, head of global economics at Capital Economics. They included several emerging markets in Europe, whose currencies were hit by fears of a war in Ukraine, as well as a general climate of risk aversion, she said.

But the trend is broad-based and has affected central banks in wealthier countries as well. South Korea’s central bank made its first 50 basis point hike in July.

Many major moves have confused investors, including in Australia, Norway and Switzerland, where the central bank unexpectedly raised the rate by 50 basis points in June. Markets had forecast that the traditionally dovish Swiss National Bank would delay rate hikes until the end of the year, but worries about inflation and the exchange rate forced policymakers to act early.

In most advanced economies, rates are rising from record lows after aggressive central bank easing in the early months of the Covid-19 pandemic. With rates remaining low by historical standards, economists expect several major central banks to raise rates by 50 basis points, or 75 bps. at its next rate-setting meetings to bring borrowing costs closer to long-term averages.

McKeown said central banks need to act quickly to get rates out of “stimulus” territory, “especially as wage growth and inflation expectations rise and there is a risk that inaction will lead to a wage-price spiral.”

The Bank of England and the European Central Bank have not yet made such a significant increase in rates. However, Matthew Ryan, senior market analyst at global financial firm Ebury, said the Bank of England “will probably need to join the 50 club to lift the pound off its current depressed levels.”

The euro reached parity with the dollar this week, but the ECB, which meets on July 21, is expected to raise rates by a more modest 25 basis points.

Strong jobs data and higher-than-expected inflation in June bolstered expectations for another big Fed rate hike at its next meeting on July 27. The target range for federal funds should reach 3.5% to 3.75% by the end of the year.

A further boost from the Fed will force many emerging markets to catch up, even though many of them began to tighten their monetary policy last year, ahead of advanced economies.

Agustin Carstens, general manager of the Bank for International Settlements, told a recent ECB-sponsored conference that emerging markets have “learned” from previous US tightening cycles. He said that while traditionally emerging markets have been raising interest rates in the wake of their advanced economy counterparts, “now they’ve started very early and you can see they’ve managed to keep their exchange rates fairly stable.”