Currency will remain strong in the Gulf as rates continue to rise

The Fed will continue to raise interest rates in a bid to reduce food and energy inflation

By Randall Kroszner

July 28, 2022, 12:48 PM

How high? Fed chairman Jerome Powell is expected to continue rate rises

Jerome Powell, chairman of the Board of Governors of the US Federal Reserve, made it clear that Fed rate raises are set to continue.

While I see headline inflation numbers reducing over the coming months as petrol and food prices come down, core inflation, that is stripping out energy and food prices, is unlikely to decline.

As a result, I believe the Fed will continue on a path of further rate rises – pulling back to a 50 basis point hike in September, and will then stay between 25 and 50 basis points for the subsequent two meetings this year.

Gulf set for more belt tightening as interest rates keep rising

Despite this, inflation will still be far above the Fed’s two percent target by the end of the year. As such, we can expect to see continued rate rises into early 2023.

However, as these rate hikes are built in, there is little impetus for the dollar to strengthen much further.

The exception to this rule is individual countries that have specific growth inflation problems.

With many Gulf economies being closely tied to the dollar, these currencies will continue to be strong.

As the global economy slows, demand for energy will weaken, putting broad downward pressure on oil. Europe in particular will be hard hit and it seems unlikely the bloc will avoid a recession.

And with natural gas prices expected to rise due to supply reduction from Russia, Europe’s ability to build up storage for the winter is weakened.

Whereas, while US growth will slow substantially and there is a risk of recession, it is not a certainty.

Overall, unless the US economy contracts sharply and unemployment skyrockets, the Fed will continue to leave rates in the four percent range for a while, to ensure that inflation, and indeed inflation expectations, move back to their two percent target.

I don’t see that happening until late 2023 at the earliest. If the Fed does keep interest rates higher for longer than markets expect, the dollar could rise again.

Randall Kroszner is Professor of Economics at the Chicago Booth School of Business, and served as a member of the Board of Governors of the US Federal Reserve from 2006 until 2009