Inflation is an even tougher opponent than expected, and the Federal Reserve is more determined than ever to win the battle.
As analysts expected, the U.S. central bank added another 75 basis points to its key rate to raise it to the 3.75%-4% range, its highest level in nearly 15 years old. The total has reached 375 basis points in six bursts since March, and further increases will be necessary, warns the Federal Reserve in its press release. At most, the pace of the next hikes could slow down, as the institution wants to take into account the effects on the economy of the rather aggressive tightening already carried out. Fed Chairman Jerome Powell recalled the lagged effect of monetary tightening on the economy while indicating that it was premature to consider a pause.
On the stock market, after having believed in a message of attenuation of monetary austerity, Wall Street plunged following the press conference in which Jerome Powell maintained the firmness of his remarks to reaffirm that the Fed still had a way to go. TO DO. The Dow Jones lost 1.6% in the session, the Nasdaq index slipped 3.4%, and the broader S&P 500 index 2.5%. Analysts now put a more than 70% chance that the Fed’s maximum rate will rise above 5% by next May, a scenario they weren’t even considering a month ago, it reads. in a text from Agence France-Presse.
Midterm elections
All of this comes less than a week before the November 8 mid-term elections, whose central theme is inflation, which has now become the main concern of American households. In fact, the broader economy is the top issue for 79% of respondents to a PEW Research Center poll, followed by the future of American democracy (70%).
Desjardins Group analysts have compared the degree of sensitivity to the various issues between Republicans and Democrats. In the PEW Research Center poll, the economic issue is very important for 92% of Republican sympathizers, but the rate drops to 65% for Democrats. For the latter, questions relating to the future of American democracy (80%), health care (79%), abortion (75%), the Supreme Court (69%) and climate change (68%) are more important in these elections. For Republicans, the issues that come closest are immigration (76%) and crime (74%).
“This split between Democrats’ and Republicans’ opinions on the importance of the economic issue reflects their opinion on the health of the American economy. Only 9% of Republican respondents consider that the economic conditions are excellent or very good, compared to 26% for Democratic sympathizers,” underlines Desjardins.
Impact in Canada
On this side of the border, the Bank of Canada instead opted last week for a 50-point hike in its target for the overnight rate, pushing it to 3.75% after a sixth increase. This year. A jump of 350 points in total compared to the rate of 0.25% in March. And it wouldn’t be over. “The Governing Council expects the policy rate to rise further. »
The Bank of Canada, however, also referred to the lag effect to add that “future rate hikes will be influenced by our assessments of: the effectiveness of monetary policy tightening, the resolution of supply issues, and the reaction of inflation and inflation expectations to rate hikes”. While taking care to remember that quantitative tightening, which consists of removing from its balance sheet the government bonds purchased during the health crisis, juxtaposes a complementary effect to increases in the key rate.
Rate differential
In his Monetary Policy Report, she notably discussed the appreciation of the US dollar against the main currencies. “Rapidly rising interest rates in the United States and increased movements into safe havens on concerns about a global recession have contributed to a significant appreciation of the US dollar. The Canadian dollar moved from 81¢US in 2021 to 0.72¢US. In its forecasts, the central bank is now counting on a dollar at 74¢US, or 4¢US less than in its July forecasts.
The key rate differential is therefore likely to gain in importance in the equation. This gap between Canada and the United States now stands at 25 points in favor of the Fed, and everything indicates that it should widen. “The rapid increase in the policy rate in the United States and the surge in the US dollar have both had a significant impact on global financial conditions. The appreciation of the US dollar also increases inflationary pressures in many countries,” the institution adds.
But if the appreciation of the US dollar contributes to imported inflation in countries that have seen their currencies depreciate, the depreciation of the Canadian dollar will partially offset the weakening of foreign demand, particularly in the United States, causing a deceleration export growth, says the Bank of Canada. The result of this dynamic remains to be seen.