By Qudsia Bano

A renewed rise in US inflation, coupled with a resilient labour market, has strengthened the case for keeping interest rates elevated for longer following the Federal Reserve’s latest rate increase, with implications for global borrowing costs, currencies and capital flows.

The Federal Reserve raised the target range for the federal funds rate by 25 basis points to 3.75%-4.00% on September 16 as inflation remained above its 2% objective and the US economy continued to show resilience.

The decision followed hotter inflation data released by the US Bureau of Labor Statistics. The Consumer Price Index rose 0.4% in August from the previous month, accelerating from a 0.1% increase in July. On a year-on-year basis, consumer prices increased 3.4%.

Core inflation, which excludes volatile food and energy prices, increased 0.3% during the month and 2.4% from a year earlier. Energy prices were among the major drivers of the increase, with the energy index rising 2.1% and gasoline prices climbing 3.9% in August.

The figures reinforced concerns that inflationary pressure in the US economy remains persistent despite an extended period of restrictive monetary policy.

Wajid Ahmed, Research Economist at the Pakistan Institute of Development Economics (PIDE), said the latest inflation numbers suggested that the Federal Reserve could not yet consider the inflation battle over.

“The bigger concern for the Fed is not a single monthly increase but whether inflation remains persistent across several months. If underlying price pressures continue, the Federal Reserve will have little room to move towards easier monetary policy and may have to keep financial conditions restrictive for longer,” he said.

Ahmed said prolonged tight monetary conditions in the United States could also have consequences outside the US economy.

“Higher US interest rates tend to keep global financing conditions tight. For emerging economies, this can mean more expensive external borrowing, pressure on capital flows and greater sensitivity to movements in the US dollar,” he added.

The Federal Reserve’s preferred measure of inflation has also remained above its target. According to the US Bureau of Economic Analysis, the Personal Consumption Expenditures price index increased 3.7% year-on-year in July, while the core PCE price index, excluding food and energy, rose 3.3%.

The Fed targets inflation of 2% over the longer run, meaning the latest readings remain well above the level policymakers consider consistent with price stability.

The US labour market has meanwhile provided the central bank with further room to focus on inflation. Bureau of Labor Statistics data showed that non-farm payroll employment increased by 162,000 in August, while the unemployment rate remained at 4.1%.

Talha Rauf, Investment Analyst at AKD Securities Limited, said the combination of sticky inflation and a relatively firm labour market had strengthened expectations that US monetary policy could remain restrictive for longer.

“The recent data have reduced the case for an early shift towards softer monetary policy. As long as employment remains relatively resilient and inflation stays above target, the Fed can afford to maintain a restrictive stance without immediately facing a major labour-market trade-off,” he said.

Rauf said the consequences would be closely watched across bond, currency and emerging-market asset classes.

“For financial markets, a higher-for-longer US rate environment generally means upward pressure on Treasury yields and continued support for the dollar. It can also make investors more selective about emerging-market assets, particularly where external financing requirements are high,” he said.

The August inflation numbers preceded the Federal Reserve’s September policy meeting and helped shape the environment in which policymakers ultimately raised rates.

In its September policy statement, the Federal Open Market Committee said economic activity continued to expand at a solid pace, domestic spending remained resilient and inflation was still elevated.

The move marked an important shift in the global interest-rate outlook because expectations earlier in the year had increasingly centred on eventual monetary easing as inflation moderated. The latest inflation readings have complicated that outlook by raising questions over how long restrictive policy will be required.

For emerging economies, including Pakistan, the implications of tighter US monetary policy are transmitted mainly through international financial markets rather than through a direct one-for-one response in domestic interest rates.

Higher returns on US assets can strengthen demand for the dollar, influence international bond yields and raise the cost at which governments and companies access foreign financing. Countries with large refinancing requirements or significant foreign-currency liabilities tend to be more exposed to such changes.

Ahmed said the effect on individual emerging economies would ultimately depend on their own external positions.

“The impact is not uniform across countries. Economies with stronger reserves, manageable external financing needs and stable macroeconomic conditions are better placed to absorb a prolonged period of high global interest rates,” he said.

Rauf said markets would now focus heavily on forthcoming US inflation and labour-market data for indications of whether the latest price acceleration was temporary or part of a more persistent trend.

“If inflation continues to surprise on the upside, markets will have to price in the possibility that US rates remain elevated for longer than previously expected. Any sustained improvement in inflation, on the other hand, would reopen the debate over when the Fed can start easing again,” he said.

With inflation still running above target and the US economy showing resilience, the focus has shifted from the September rate increase itself to how long the Federal Reserve will need to maintain restrictive monetary conditions, making the path of US inflation a key driver of global financial conditions in the coming months.

Credit: INP-WealthPk