Despite Ukraine crisis, global rate rises seem like done deal

As the US wages war on inflation, China must follow the Fed’s lead or accept the consequences of a weaker renminbi exchange rate

With so many uncertainties bearing down on the global economy, you’d hardly guess that central banks would be adding to the gloom with the prospect of higher interest rates. But global interest rate rearmament seems like a done deal with the US Federal Reserve set to press ahead with higher rates from as early as next week’s

Federal Open Market Committee meeting.

An early move has been flagged for a long time and should set in motion a series of rises that should take the Fed Funds rate to a target of 2.5 per cent in the longer term beyond

2024, according to the US central bank’s own assessment.

The Fed is set to wage war on the growing threat of much higher inflation becoming embedded, raising the risk that US interest rates could go higher than expected. With headline US inflation currently running at a 40-year high of

7.5 per cent, the Fed will show little mercy in its quest to stop a damaging wage price spiral emerging.

The days of easy money and near-zero interest rates are over in the United States, and the rest of the world will have to go along or pay the penalty of exchange rate weakness against a resurgent US dollar. The dollar is being bid higher by a flood of safe-haven flows on the back of the Ukraine crisis, and rising rate expectations will simply give more encouragement to dollar currency bulls.

While calls to delay tightening have understandably arisen over the growing crisis in Ukraine, Fed chairman Jerome Powell has signalled that the central bank may initially raise rates less than expected. But it’s only likely to be a temporary hiatus.

In the longer term, price stability is the Fed’s overriding goal. It can ill-afford to turn its back on the inflationary forces that are building up right now.

It’s not just rampant energy prices that are the worry. US employment demand is thriving, with last week’s non-farm payrolls data showing 678,000 new jobs were added to the economy in February, the biggest gain in seven months.

The jobless rate fell to 3.8 per cent from 4 per cent a month earlier, moving closer to the 50-year low of 3.5 per cent hit just before the Covid-19 pandemic struck. Booming labour markets and soaring inflation risks spell double trouble that the Fed has to tackle now.

This is not being lost on tightening expectations, with some believing the key

Fed Funds rate could rise to 2 per cent by as early as the end of this year. US money market futures are more dovish now, discounting Fed Funds peaking at 2 per cent by the end of 2024, reflecting the risk of extended Ukraine tensions leading to another global downturn.

The Fed’s intention to tighten monetary policy poses a big dilemma for other central banks, which must decide whether to fall into line or risk falling behind in the inflation fight. Until recently, a consensus had been building that global inflation risks would peak in the first quarter of 2022, but since the situation in the Ukraine has deteriorated, that outlook has changed.

The longer the crisis extends and energy prices remain highly elevated, the greater the chances that inflation will take deeper root, forcing central banks to respond with higher-thananticipated interest rate rises.

The Bank of Canada raised key rates last week to 0.5 per cent from a record low of 0.25 per cent, while the Bank of England took action for the second time in three months, raising rates in early February to 0.5 per cent. Others are taking their time. The European Central Bank recently changed tack on a pledge not to raise rates in 2022, but the time frame is still unclear on when to dismantle the unconventional policies that have kept the euro zone afloat for much of the past decade.

The Bank of Japan will probably bow to higher interest rates later this year to defend the yen.

Once the Fed goes on the inflation offensive, it raises the odds that China’s interest rate easing cycle is over. China must follow the Fed’s lead on rates or accept the consequences of a much weaker renminbi exchange rate as the dollar strengthens. Monetary independence will come at a cost.