Macroscope | US inflation and interest rates: why the Fed needs help from China
- Since the inflationary pressure on the US is partly a consequence of supply chain dislocations, fast and hard rate hikes won’t be enough if Chinese production does not get back into top gear
- Such considerations are why investors expecting the US dollar to strengthen against the yuan may be disappointed
As the Federal Reserve agonises about how far and how fast to raise interest rates to combat spiking US inflation, the People’s Bank of China is more likely to ease policy as it seeks to support Chinese economic growth. The contrast in priorities is obvious, the implications for markets less so.
In the United States, the pressure is on the Fed to act in the face of rising prices. The US consumer price index hit 7.5 per cent year on year in January, its highest annualised increase since February 1982. That’s a pretty uncomfortable statistic for the Fed and the Biden administration which had both, until recently, sought to characterise upwards US inflationary pressure as transitory.
Fed policymakers who had previously been inclined to “look through” evidence of rising prices now exhibit a pressing need to respond aggressively to those selfsame inflationary pressures.
This situation necessarily erodes a China-US interest rate differential that has long been skewed in the renminbi’s favour and consequently has implications for how the currency markets view the appropriate level for the US dollar/Chinese yuan exchange rate.