The world’s central banks are injecting a new complication into the Federal Reserve’s decision on when to raise interest rates from record lows. They’re cutting their own rates. Last weekend, China’s central bank slashed key rates for a second time in three months to try to stimulate the slowing Chinese economy. That move followed the European Central Bank’s decision in January to begin buying bonds to try to revive a flat-lining economy, a step the Bank of Japan is also pursuing.
The Fed, by contrast, wants to start raising rates soon to prevent the strengthening U.S. economy from igniting inflation or causing bubbles in assets like stocks or homes. But the Fed needs to be cautious, in part because raising rates while other central banks are cutting theirs would likely drive up the U.S. dollar’s value.
A stronger dollar could potentially be harmful because it would make U.S. imports cheaper, reduce overall prices and likely make it harder for the Fed to meet one of its mandates- lifting excessively low inflation to a healthier level. It would also squeeze U.S. exporters by making their U.S. goods more expensive for overseas buyers. A sharp slowdown in exports would weaken the U.S. economy.
The conflicting central bank policies reflect America’s economic might compared with the sluggishness of most other major economies.
Now the Fed is moving in the opposite direction. It ended its bond-buying program last fall. And it must determine when the U.S. economy will be strong enough to justify lifting short-term rates from near zero, where the Fed has kept them since late 2008.
Most economists expect the Fed to finally raise rates in either June or September. A clearer signal could come in two weeks with the Fed’s latest policy meeting, after which Chair Janet Yellen will hold a news conference.
But questions persist about the underlying health of the U.S. economy. Wages, which should be surging in an improving job market, until recently were barely keeping up with inflation. And the price gauge the Fed monitors most closely rose just 0.75 per cent last year, well below its 2 per cent target.
One reason: inflation is stuck below what the Fed considers an optimal level. The dollar hasn’t waited for the Fed rate hike; it’s been surging. Since June 30, the dollar has climbed 19 per cent against the Japanese yen and 22 per cent against the euro. A rate hike in June or September likely would send the dollar even higher, thereby, putting further downward pressure on inflation. The Fed hasn’t sounded overly concerned about the dollar’s impact so far.
