The rise in the dollar makes many products – such as food and fuel – much more expensive. But they are not the only consequences for other countries, including European ones, such as Portugal.
The US Federal Reserve is focused on controlling price increases. But thousands of miles away, countries are reeling in their hard-fought campaign to strangle inflation, forcing their central banks to raise interest rates faster and faster, and with the appreciation of the dollar pushing the value of your currencies down.
“We see the Fed [banco central dos EUA] be as aggressive as it has been since the early 1980s. They are willing to endure higher unemployment and a recession,” said Chris Turner, global head of markets at ING bank. “That’s not good for international growth.”
The Federal Reserve’s decision to raise interest rates by 0.75 percentage points in three consecutive meetings while signaling that more rate hikes are on the way has caused their counterparts around the world to tighten as well. If they fall far short of the Federal Reserve, investors could take money from their financial markets, causing serious disruptions.
Central banks in Switzerland, the UK, Norway, Indonesia, South Africa, Taiwan, Nigeria and the Philippines followed the Fed in raising interest rates over the past week.
The Fed’s stance also boosted the dollar to a two-decade high against a basket of major currencies. While this is useful for Americans looking to shop abroad, it is very bad news for other countries as the value of the yuan, yen, rupee, euro and pound falls, making it more expensive to buy essential items such as food and fuel. import. This dynamic – with the Fed essentially exporting inflation – is increasing the pressure on local central banks.
“The dollar is not getting stronger in isolation. It has to guard against something,” explains James Ashley, head of international market strategy at Goldman Sachs Asset Management.
The punitive consequences of the dollar’s rapid appreciation have become more apparent in recent days. Japan intervened last Thursday for the first time in 24 years to support the yen, which has fallen 26% against the dollar so far. (The Bank of Japan has remained a major off-trend central bank and has resisted rising interest rates despite rising inflation.)
China is watching currency markets after the yuan plunged to its lowest level against the dollar since the global financial crisis, while European Central Bank president Christine Lagarde warned on Monday that the euro’s sharp depreciation “contributed”. to the accumulation of inflationary pressures”.
The UK shows how quickly the situation can spiral out of control if global investors choke it after the new government’s economic growth plan is unveiled. The British pound plunged to a record low against the dollar on Monday, following the unorthodox experience of major tax cuts, while the rise in debt in the UK set alarm bells ringing.
The ensuing chaos forced the Bank of England to announce an emergency bond-buying program to try to stabilize markets, and prompted an admonition from the International Monetary Fund, which said the British government should rethink.
The global financial system is currently “like a pressure cooker,” Turner says. “You have to have a strong and credible policy, and any policy mistakes are punished.”
The threat to emerging markets
The World Bank recently warned that the risk of a global recession in 2023 has increased as central banks around the world simultaneously raise interest rates in response to inflation. And of those, too, the trend could result in a series of financial crises in emerging economies – many of which are still recovering from the pandemic – “that would cause them lasting damage”.
The greatest impact can be felt in countries that have issued dollar-denominated debt. Paying these obligations becomes more expensive as local currencies depreciate, forcing governments to cut spending in other areas, while wild inflation lowers living standards.
The decline in foreign exchange reserves is also a cause for concern. The dollar shortage in Sri Lanka contributed to the worst economic crisis in the country’s history and forced the president to resign earlier this year.
The risks are exposed by the magnitude of the rate hikes in many of these countries. Brazil, for example, kept interest rates stable this month, but only after 12 consecutive hikes, pushing the benchmark rate to 13.75%.
Nigeria’s central bank raised interest rates to 15.5% on Tuesday, far more than economists had expected. In a statement, the central bank noted that “the current monetary policy tightening by the US Federal Reserve Bank is also putting upward pressure on local currencies around the world, impacting domestic prices.”
Can the pain be stopped?
The last time the dollar experienced a similar rise, in the early 1980s, policymakers in the United States, Japan, Germany, France and the United Kingdom announced a coordinated intervention in the foreign exchange markets that came to be known as the ‘Plaza- agreement’.
The dollar’s recent rally and the pain it has caused in other countries has sparked talks that it may be time for a new deal. But the White House has thrown cold water on the idea, making it seem unlikely for now.
“I don’t expect us to go there,” Brian Deese, the director of the National Economic Council, said Tuesday.
However, the Federal Reserve is expected to remain on track. This means that the dollar could rise even further and that other central banks could not relax.
The additional strength of the dollar and higher US interest rates is “something that we absolutely have to anticipate, and the consequences are quite drastic,” said Ashley of Goldman Sachs Asset Management.