The Federal Reserve is expected to raise interest rates another three-quarters of a point this week in its effort to curb inflation, further amplifying the strength of a rapidly rising dollar.
That is increasingly seen as a problem in Europe, where concerns about a recession are mounting as currencies lose power to the US dollar.
Europe is also facing economic pressures from Russia’s war against 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 in the winter.
The concerns spark new complaints from those who see the Fed’s actions potentially causing more problems than they will solve if Europe takes a serious blow.
“This is my real frustration with what the Fed is doing right now. Frankly, the global geopolitical economic conditions don’t justify 75 basis points,” Claudia Sahm, a former Federal Reserve economist and founder of Sahm Consulting, said in an interview with The Hill.
“Our monetary policy is crushing Europe and emerging markets. The Fed is almost certainly making the hardships in Europe worse,” she added.
Rising interest rates make it more expensive to borrow money and in fact make the US dollar more valuable compared to other currencies.
The euro has fallen about 12 percent against the dollar compared to the dollar, reaching a one-to-one ratio, its weakest level in about 20 years. The British pound has fallen more than 15 percent year-on-year to its lowest level since the mid-1980s.
The Japanese yen is down 20 percent against the dollar, the Chinese renminbi is down about 9 percent, the Indian rupee about 7 percent and the Swiss franc about 5 percent.
The changing values of the currency have a number of real-world effects.
The dollar continues for US travelers abroad, but makes it more expensive for US manufacturers to export goods. It cuts costs for US importers at a time when supply chain problems related to the coronavirus and high demand from the pandemic have fueled inflation.
The international knock-on effects of a strong dollar are unlikely to top the Fed’s current priority list. It is more urgent to get to grips with the 40-year high inflation, which was initially mischaracterized by Fed economists and Treasury officials as “transient” and not a serious cause for concern.
In fact, the Fed may view an artificially strong dollar as a good thing in the near term, as it benefits US consumers, despite the fact that global economies are being forced 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 US, which is one of Europe’s largest trading partners.
Domestic producers have also been hit hard by the strong dollar and are eager for exchange rates to flatten in the interest of selling more goods abroad. More Fed rate hikes will continue to undermine US manufacturing performance.
But the Fed is aware that inflation is sensitive to higher import costs. Recent research from the New York Fed showed that high import prices due to supported supply chains were a major reason behind the rising prices US consumers felt in the wake of the pandemic.
Price increases passed on to domestic producers through higher import prices have “more than doubled during the Covid period,” according to a study published in August by the New York Fed’s Liberty Street Economics blog.
Europe is in a particularly difficult position because of the war between Russia and Ukraine, which, despite Ukraine’s progress in recent weeks, shows little sign of slowing down.
Faced with a barrage of Western sanctions, now including a price cap on Russian energy exports, Russia halted supply of natural gas to Europe at various times over the summer due to maintenance problems with a major pipeline.
European authorities responded by introducing new energy regulations to lower “astronomical” electricity prices while moving their economies away from Russia’s previously cheap and abundant natural gas.
In the United Kingdom, the government has raised its price cap on household energy expenditure by 80 percent for October as the country faces rising energy prices.
“We are supporting this country this winter and next, tackling the root cause of high prices, so we are never in this position again,” British Prime Minister Liz Truss said in a statement on the energy crisis earlier this month.
Elsewhere in Europe, countries lowered their forecasts for economic growth, with Finland lowering its 2023 gross domestic product estimate to 0.5 percent from a previous estimate of 1.1 percent.
“Rising prices are hampering Finland’s economic growth,” the country’s finance ministry said in a statement Monday.
“Finnish GDP is set to grow by 1.7 percent in 2022, although growth will slow significantly towards the end of the year. Consumer price increases have accelerated to nearly 8 percent and will grow by an average of 6.5 percent this year. Rising prices will weaken household purchasing power and keep consumption growth subdued in the second half of the year. Despite the increase in employment, real household incomes are declining and there is little left for savings,” the ministry said.
Analysts expect the Fed to continue its rate hikes in light of inflation, which now stands at 8.3 percent a year, with core inflation rising 0.6 percent from July to August.
“After this week’s upswing in the US [consumer price index]Investors will focus on the Fed’s decision next Thursday, with markets now firmly trading at least 75 [basis point] increase,” Deutsche Bank analysts wrote in a note last week.
“A lot of attention will be given to policymakers’ expectations about the path and magnitude of future increases. Our US economists expect a 75 [basis point] moving next week and recently published … why the final rate should reach 5 percent,” they wrote.