The world of official rates is divided into three parts. The advanced countries, including Europe and the Euro-area, the UK, the US, Australia, New Zealand, Japan and Israel all have ultra-low rates, below 0.25%. They got there largely thanks to the pandemic and have stayed there in the belief that their inflation will stay low as in the previous decade – or will return to a low figure after a short upsurge as the economies recover.
The principal emerging-market economies have interest rates around 4%. China is at 3.85%, India at 4%, Brazil at 4.25%, South Africa at 3.5%, and Mexico at 4%. Their inflation rates are higher than the advanced country average and they wish to offer some protection to their currencies and to avoid an inflationary problem reappearing.
Some emerging economies already have a serious inflationary problem, usually brought on by governments that wish to live beyond their means. Venezuela and Argentina are the worst with interest rates at 58% and 38%, but Turkey now has a growing inflationary problem and interest rates at 19%. Lebanon and Zimbabwe are also struggling with very high inflation.
Dollar drives fledgling economies
Emerging economies are vulnerable to dollar pressures. When the dollar is strong they experience falling currency values, which adds to the cost of the imports and to the true cost of repaying foreign currency debts. China is especially keen to draw a big distinction between its prudent monetary and fiscal policy and that of the US, which it criticises for being too lax.
China is also well aware of US pressures to get the Chinese currency higher rather than lower given the large balance of payments deficit the USA runs with China. China has probably done enough tightening to avoid an inflationary problem, though it has experienced a sharp increase in input costs from commodity-price rises on the back of easy US money and the world recovery.
Brazil, with 8% inflation, and India, with 6%, have more of an inflation problem – and may need to take more action. Markets are expecting rate rises again in both Brazil and Russia on top of the recent changes. The countries with rapid inflation have a lot more to do to re-establish price stability.
The ones to watch
The crucial issues about rates are the ones that apply to the big three: the US, Japan and the Euro-area.
Japan is likely to live for longer with rates around zero and continuing programmes of money creation and bond-buying. There is still no general inflation in Japan despite the commodity and energy-price moves this year. The government will want more stimulus. Euro-area officials have just completed a meeting reviewing its longer-term money policy. It is possible they will conclude that they need to allow some overrun of their 2% target for a while to try to boost price rises to nearer the average over a period of years, as the Fed is doing. Whilst there is a pick-up in Euro-area inflation, it may well be short-lived as an ageing population with a savings habit looks a bit more like Japan than the US.
It is the Fed that has the inflationary headache. It has done so much more to boost money and activity relative to the size of their economy than the others. It already has inflation at 5%, and a government that wishes to run large deficits whilst boosting low-end wage rates.
The Fed last week suggested an earlier rate rise than before and a higher short-term rate of inflation. It will soon need to spell out when they plan to end bond buying and reassure about the pace of withdrawal of stimulus.
So far, markets have broadly accepted Fed leadership and want to believe the inflation will be a one-off. The Fed will need to take the action to justify this confidence. The Bank of England and the Bank of Canada have already announced tapering of their bond purchasing. The Fed is behind in moving policy, conscious that its words could trigger a global fallout.
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