Fed to raise policy rate by another 0.50% to stem inflation…A move that will drive up the US dollar ahead (Business Brief No.3970)

As previously signaled, it is expected that the Federal Reserve (Fed) will raise its policy rate by another 0.50 percent at the upcoming Federal Open Market Committee meeting, May 3-4, 2022, with the aim of combating elevated inflation. The Fed may continue to place emphasis on maintaining price stability amid accelerating inflation. Headline inflation, based on the Consumer Price Index (CPI), surged to 8.5 percent in March 2022. The broad-based increases in prices of goods and services, particularly energy, foods and residential homes amid the protracted Russia-Ukraine conflict that has boosted global inflation, will prompt the Fed to raise its policy rate by another 0.50 percent at the upcoming meeting. Additionally, the Fed may begin to shrink its near USD9 trillion balance sheet as signaled earlier. The policy rate hike by another 0.50 percent is considered an aggressive move that the Fed may have chosen in order to control inflationary cycles. The Fed may be of the view that a marginal or slow increase in its policy rate may not be adequate to tame inflation.
The Fed’s accelerated policy rate hike will cause the US dollar to strengthen, while other central banks that implement monetary policies in contrast to that of the Fed will face pressure from capital outflows and weakening currencies. In Asia, most countries continue to maintain accommodative monetary policies as their economies are beginning to bounce back. Different monetary policy stances between the US and Asian countries will likely narrow their interest rate gap. This factor may cause capital to flow out from Asian countries and in turn weaken their currencies. Central banks, therefore, are bound to experience challenges in the implementation of loose monetary policies. They will also have to weigh between risks to financial stability and economic growth, going forward.