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Inflation in the US has fallen unexpectedly sharply. That makes it more likely that the Fed will pause its series of rate hikes.
US inflation unexpectedly fell sharply in May. Consumer prices rose 4.0% year over year, the Labor Department said. Experts had expected the decline to be less severe. In April, the inflation rate remained at 4.9%.
Overall, U.S. consumer prices have been trending lower in recent months. Inflation has fallen for eleven consecutive months. Last June it was 9.1% – the highest level in 40 years.
Inflation remains above target
For financial markets, U.S. inflation data are currently receiving special attention because they are highly correlated with the Federal Reserve’s monetary policy. Inflation in the US remains well above the 2.0% target, so monetary tightening is still considered appropriate.
The question, however, is how long and at what pace. If U.S. inflation falls, at least the chances of a slower and modest rate hike by the Federal Reserve increase. Given Wednesday’s rate decision, many market watchers were already expecting a pause in rates, even if it was too early to give any clarity on inflation.
Commerzbank experts Christoph Balz and Bernd Weidensteiner commented that at the next meeting, the federal government “may suspend the expected interest rate and maintain the key interest rate corridor at 5.00% to 5.25%”. However, it is unclear whether this has signaled the final end of rate hikes.
what economists pay special attention to
The reason Commerzbank economists are urging caution is the so-called core inflation rate. The ratio is also used to assess the situation, excluding energy and food prices, which are particularly vulnerable to volatility.
According to experts, it is a better indicator of the overall movement of prices than the overall exchange rate. Core inflation fell to 5.3% from 5.5% – economists had expected a slight decline of 5.2%.
As a result, Shaan Raithatha, an economist at fund provider Vanguard Europe, does not see the current data as an inflection point for U.S. monetary policy: “Inflation will continue to decline, according to our assessment, but will likely remain above 3% by the end of the year. Under these circumstances, the Fed is unlikely to cut rates this year.”
Why Monetary Policy Matters in the U.S.
Stock market investors, in particular, are hoping that the Fed’s recent aggressive rate hikes will slow down. This could provide momentum for further price increases. Not least because of this, the Fed’s monetary policy also matters to many in Germany and elsewhere in Europe.
Finally, many people invest in retirement products, such as mutual funds, that generate returns through the stock market. A prosperous U.S. stock market has a positive effect on European and German stock markets, which are often based on so-called U.S. norms.
The Fed’s interest rate policy also has a major impact on the economy. High interest rates could be a drag on the U.S. economy. As interest rates rise, financing conditions for firms and private households deteriorate. Given the global economic network and the high dependence of the European economy on the US and Wall Street, a US recession would also have a major impact on the German economy, which is still quite weak at the moment.
Impact on the global economy
The foreign exchange market is also heavily influenced by US monetary policy. That’s why the euro is reacting today to the fact that the possibility of a pause in U.S. interest rate hikes, and the fact that the European Central Bank may hike again this week, is priced higher today. High interest rates in the United States may lead investors to prefer to invest their money in U.S. bonds to increase investment returns.
Thus, a sharp appreciation of the dollar and high interest rates in the United States pose a significant risk, especially for many so-called emerging countries. For one thing, many bonds are denominated in dollars, making repayments more expensive for highly indebted countries and companies. On the other hand, investors may withdraw funds from these countries and transfer them to the United States in search of higher and safer returns, which may lead to turmoil in global financial markets.
The recent bank failures in the United States have shown that the monetary policy of the Federal Reserve can also have a negative impact on financial institutions. The global network of financial markets can mean that a local banking crisis initially spreads and causes problems in other countries as well.