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Macroscope | Why the Fed’s hawkish inflation turn isn’t necessarily bad news for China’s economy
- The fiscal and monetary policy options at Beijing’s disposal should insulate it if tighter Fed policy tips the US economy into recession
- The combination of broad pledges of government support and a shift towards an economy more driven by domestic demand will ease China’s exposure
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The US Federal Reserve has finally rediscovered its inner hawk and kicked off what will be a succession of interest rate increases. Quantitative tightening will surely join the policy mix. There could be spillover effects that affect the Chinese economy, but Beijing has mitigating fiscal and monetary policy options at its disposal.
China is at a completely different stage in the economic cycle to the United States. The Fed is focused on inflation while Beijing’s priority is supporting the pace of economic growth, but the steps Beijing is adopting are also the policies that should stand China in good stead if Fed tightening ultimately tips the US economy into recession.
Fed chair Jerome Powell says that “the probability of a [US] recession within the next year is not particularly elevated”. Either way, having until recently categorised rising US prices as “transitory”, the central bank is now determined to drive down US consumer price inflation. That figure was 7.9 per cent year on year in February, which stands in stark contrast to China’s annualised 0.9 per cent reading last month.
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Last week, the Fed increased its benchmark interest rate by 25 basis points to a target range of 0.25 to 0.5 per cent. It now appears set on further rate rises over the course of 2022 that should lift the key Fed funds rate to 1.9 per cent by the end of the year, with more increases next year taking it to 2.8 per cent by the end of 2023.
No one can know whether the Fed tightening cycle will play out like this. Some would argue that if US financial markets take fright as these rate increases are announced, the Fed will pull back.
But no one should underestimate the significance of the Fed rediscovering its fervour for tackling inflationary pressures. If US inflation proves stubbornly resistant to initial policy tightening, the Fed might feel compelled to keep going, even at the risk of starting an economic recession.
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