What Happens If The World’s Central Banks Seek To Out-Hike The Fed?

What Happens If The World’s Central Banks Seek To Out-Hike The Fed?
Theodora Lee Joseph, CFA

over 1 year ago2 mins

Central banks tend not to raise interest rates on a whim: they know that doing so risks tipping the economy into a recession. But with inflation proving to be both high and persistent in countries around the globe, many central banks have come to realize they need to get on with some hiking – and fast.

What started as a few cautious hikes, here and there, is now threatening to turn into a full-blown, global hike race. The US Federal Reserve’s (the Fed’s) third consecutive 0.75 percentage point hike last week has made it one of the quickest and most aggressive central banks in the race, as you can see from the chart. And this creates an awkward situation for the rest.

See, the more the Fed hikes rates, the stronger the US dollar becomes, as international savers and investors look to buy up as much of the higher-yielding dollar-denominated assets as they can. But the stronger the dollar becomes, the weaker other currencies become relative to it. And those weaker local currencies make taming inflation in those countries much tougher, since all their dollar-priced imports, especially dollar-priced commodities, become more expensive. It also causes a problem for emerging economies that don’t borrow in their own currencies: their government debt is usually denominated in dollars, so the higher-priced greenback makes it more expensive for them to service and repay their loans.

So, for central banks that have decided to stare recession risks dead in the face, there’s some logic in trying to out-hike the Fed: it could help them prop up their own currency and take some of the steam out of their import inflation. Just don’t expect this central bank hiking race to be any good for stocks – as if history’s any guide, a recovery can be expected only when a peak in interest rates and inflation is near. For now, that appears a ways off.

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