Not All Inflationary Pressures Are Created Equal

Not All Inflationary Pressures Are Created Equal
Theodora Lee Joseph, CFA

over 1 year ago2 mins

With the US, the UK, and the eurozone all battling high inflation, it would be easy to assume that their central banks all need to be equally aggressive in their interest rate hikes. But you can see above that the blame for rising prices varies from region to region, which suggests policymakers need to take a unique approach in each case.

Just look at the eurozone, where energy prices are having the biggest impact of the three. That’s because it’s the region that’s been the most directly impacted by Russia’s invasion of Ukraine. But keep in mind that this isn’t a structural problem, baked indefinitely into the region’s economic outlook. In fact, the European Central Bank might see it as just a blip, in turn holding off on hiking interest rates too fast and leaving the government to help households in the meantime.

The US is saddled with exactly the same inflation rate as the eurozone, but its services industry is much more to blame. That’s a stickier problem, given that inflation in its services sector is largely down to a shortage of workers: businesses have had to pay higher wages to compete for new starters, which are costs they’ve then passed on to customers to protect their bottom lines. So it’s no wonder that the Federal Reserve has been so aggressive in raising rates.

The UK is in a similar boat to Europe, but its overall inflation is higher than both Europe and the States. So while the services sector isn’t so heavily to blame for its predicament, it’s going to have to be closer to America’s approach to bring inflation under control. So ultimately, both America’s and Britain’s currencies are in good stead: higher interest rates increase investor demand for a country’s tender, which suggests both the British pound and the US dollar are both on an upward trajectory from here on out.

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