Strong US dollar boomerang over Europe

The Federal Reserve is expected to raise interest rates an additional three-quarters of a point this week in its effort to bring inflation down, further increasing the strength of a rapidly rising dollar in the process.

This is increasingly seen as a problem in Europe, where worries about a recession are growing as currencies lose power to the US dollar.

Europe is also facing economic pressures from Russia’s war on Ukraine, with growing fears that Russian President Vladimir Putin could use energy as a powerful weapon this winter. Many European countries depend on supplies from Russia to heat homes during the winter.

The concerns are prompting fresh complaints from those who believe the Fed’s actions could cause more problems than they will solve if Europe takes a serious hit.

“That’s my real frustration with what the Fed is doing now. Frankly, global geopolitical economic conditions don’t warrant 75 basis points,” Claudia Sahm, a former Federal Reserve economist and founder of Sahm Consulting, said in a statement. an interview with The Hill.

“Our monetary policy is crushing Europe and emerging markets. The Fed is almost certainly making the difficulties in Europe worse,” she added.

Rising interest rates make it more expensive to borrow money and make the US dollar more valuable than other currencies.

The euro is down about 12% on the year against the dollar, hitting a one-to-one ratio, the weakest level in about 20 years. The pound is down more than 15% on the year to its lowest level since the mid-1980s.

The Japanese yen is down 20% against the dollar, the Chinese renminbi is down about 9%, the Indian rupee about 7% and the Swiss franc about 5%.

The changing values ​​of currencies have a number of real effects.

The dollar goes further for American travelers abroad, but it makes it more expensive for American manufacturers to export goods. It is cutting costs for U.S. importers at a time when coronavirus-related supply chain issues and strong demand resulting from the pandemic have helped fuel inflation.

The international repercussions of a strong dollar are unlikely to be at the top of the Fed’s current priority list. There is more urgency to tackling 40-year high inflation, which was initially mislabeled by Fed economists and Treasury officials as “transitory” and not a cause for serious concern.

The Fed may even see an artificially strong dollar as a good thing in the short term, as it benefits US consumers, even as it forces global economies to recalibrate their import and export dynamics.

But a major recession in Europe, where central banks are also raising interest rates to fight inflation, is not in the interest of the United States, which is one of Europe’s main trading partners. Europe.

Domestic producers have also been hit hard by the strong dollar and want to see exchange rates stabilize in the interest of selling more goods overseas. Further interest rate hikes by the Fed will continue to undermine the bottom line of the US manufacturing sector.

But the Fed is aware that inflation is sensitive to rising import costs. Recent research from the New York Fed showed that high import prices due to sustained supply chains were a major reason for the higher prices felt by American consumers in the aftermath of the pandemic.

According to a study published in August by the New York Fed’s Liberty Street Economics blog, the price increases passed on to domestic producers due to higher import prices “more than doubled during the Covid period”.

Europe is in a particularly difficult situation due to the Russian-Ukrainian war, which shows few signs of abating despite Ukraine’s advances in recent weeks.

Facing a barrage of Western sanctions that now include a price cap on Russian energy exports, Russia cut off natural gas supplies to Europe at various times over the summer, citing maintenance issues with a pipeline major.

European authorities have responded by implementing new energy regulations to drive down “astronomical” electricity prices while distancing their economies from once cheap and plentiful Russian natural gas.

In the UK, the government has increased its price cap on household energy spending by 80% for October as the country grapples with soaring energy prices.

“We are supporting this country through this winter and into the next, and we are tackling the root cause of high prices, so we will never be in this position again,” British Prime Minister Liz Truss said in a statement. press release on the energy crisis at the beginning of the month.

Elsewhere in Europe, countries have cut their forecasts for economic growth, with Finland lowering its estimate of gross domestic product for 2023 to 0.5% from a previous estimate of 1.1%.

“Rising prices are hampering Finland’s economic growth,” the country’s finance ministry said in a statement on Monday.

“Finland’s GDP will grow by 1.7% in 2022, although growth will slow significantly towards the end of the year. Consumer price inflation has accelerated to nearly 8% and will rise an average of 6.5% this year. The rise in prices will weaken household purchasing power and keep consumption growth weak at the end of the year. Despite employment gains, real household incomes are falling and there is little money left for savings,” the ministry said.

Analysts expect the Fed to continue its rate hikes in the face of inflation, which now stands at 8.3% a year, with core inflation rising 0.6% from July to August.

“After this week’s bullish hit on the U.S. [consumer price index]investors will focus on the Fed’s decision next Thursday, with markets now solidly valuing at least a 75 [basis point] rise,” Deutsche Bank analysts wrote in a note last week.

“Much attention will be paid to the expectations of policymakers regarding the trajectory and magnitude of future hikes. Our US economists expect a 75 [basis point] move next week and have recently posted…why the terminal rate should hit 5%,” they wrote.