Accept the cold reality and tighten your belt

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Accept the cold reality and tighten your belt

The U.S. fed funds rate has reached 15-year highs of 3.75 percent to 4 percent after the Federal Reserve last week delivered the fourth straight hike in an unprecedented yet widely anticipated move.

U.S. inflation has been flying despite the steepest tightening campaign since the 1980s. The inflation rate jumped 8.2 percent on year in September, largely from supply disruptions from the protracted Russia-Ukraine war rather than from strong demand. Even counting out volatile energy and food prices, consumer prices soared 6.6 percent, the steepest in 40 years.

Fed Chair Jerome Powell said it was “very premature to be thinking about pausing” rate increases as he feared “if we don’t get inflation under control [...] we’re in a situation where inflation is now entrenched, and the unemployment costs, in particular, will be much higher potentially.” Although the U.S. central bank could begin slowing down the pace, Powell stressed that when the moderation will take place is less important than how high the bank will ultimately raise the interest rate to tame inflation.

The extended tightening in the U.S. makes the Bank of Korea agonize over its rates hikes on Nov. 24. It would have to raise the Korean base rate to prevent the flight of foreign capital and instability in the foreign exchange market, as the gap with the U.S. target range has widened to 1 percentage point. The question would be how high it can afford to push up the rate. Korea’s inflation gained 5.7 percent from a year ago in October due to a spike in public utility charges. The headline inflation is expected to run above annual gain of 5 percent until March next year. Given the inflation chart and gap with U.S. rates, the Korean rate would have to rise further.

But the economic slowdown could worsen. The industrial data in September showed triple contractions in output, consumption and capital investment.

The rapid increases in the U.S. rate have only fueled strength in the dollar value against currencies of other countries. The U.S. is not minding woes of other countries due to the super-strong dollar. Since the Fed simply has liability only toward American people, it will pursue its rate policy entirely based on national interests.

Unlike past financial crisis, policy collaboration among governments and central banks around the world cannot be expected. Economic participants must brace up for a lengthy painful ride.
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