Weekly SmartPills #6

MONETARY POLICIES: A FIERY MAY

A troubled start to the month: reflections on the economic landscape
A truly tumultuous start to the month, but we expected it. The economic landscape is anything but calm at the moment. After the FOMC meeting on May 3rd and the European Central Bank's meeting on May 4th, the economic outlook has been further scaled back, but there are also positive aspects. The fight against inflation is not over yet, but first, we must ask: what is inflation?

Inflation: Definition and Causes

Inflation is a generalized and sustained increase in the prices of goods and services in an economy. When prices rise, the purchasing power of money decreases because people can buy fewer goods with the same amount of money. There are several reasons why inflation can occur, including an increase in demand, a decrease in supply, higher production costs, and expansionary monetary policy. To counter inflation, economic authorities can adopt various measures. One of these is raising interest rates, which makes money more expensive and reduces the demand for loans and goods. Additionally, authorities can limit the amount of money in circulation through restrictive monetary policies, such as controlling bank reserves and selling government bonds. But then, what economic policies have been implemented in the past week?

American Economic Scenario: Labor and Inflation

The important meeting of the American Federal Reserve concluded just under a week ago, and without much suspense, it resulted in another interest rate hike. It’s worth mentioning that this might be the last hike (in this case, 25 basis points). The opinions are truly divided: some believe we’ve reached the pivotal moment, while others predict an additional 25 basis point increase at the upcoming FOMC meeting on June 13-14. Over the past year, American interest rates have risen from 0.25% to 5.25%. Let’s remember that we are in a scenario (the American one) where, despite very encouraging labor market data, we still face strong inflation, which could worsen given the recent banking situations. The Fed has thus found itself in an uncomfortable position. On one hand, it was necessary to raise interest rates to bring inflation back to "normal" levels (optimistically 2%, realistically 4%), while on the other hand, they must avoid worsening the situation many American banks (especially regional ones) are facing.

ECB Rate Hike: An Expected Step

Twenty-four hours after the Fed, it was the turn of the European Central Bank. Its primary objective is also to bring inflation back to "sustainable" levels. Again, we didn’t expect any surprises, and the rate hike was expected, which it was: 25 basis points. Currently, we have a refinancing rate of 3.75% and a deposit rate of 3.25%. We eagerly await mid-June, when both commissions will meet again to decide whether to tighten monetary policies or continue to tackle the persistent inflation.