22.03.202209:51 Forex Analysis & Reviews: Former US Treasury Secretary Lawrence Summers points to 5% interest rate

Former US Treasury Secretary Lawrence Summers said that the US Federal Reserve would have to raise interest rates higher than officials were currently projecting if it wanted to regain control of inflation.

Former US Treasury Secretary Lawrence Summers

Last week, the central bank raised the benchmark rate by 25 basis points for the first time since 2018. Moreover, it stated that another six rate hikes were likely in 2022. However, Summers believes that the central bank probably underestimates the severity of price pressures. The risk of economic recession will eventually push the Fed to raise borrowing costs. "Ultimately we're going to need 4-5% interest rates, levels they're not even thinking of as conceivable," Summers said. "They're recognizing that they're behind the curve. They've still got a long way to go."

Fed officials estimated last week that interest rates would reach nearly 1.9% by the end of the year, then they would rise to 2.8% in 2023 and would remain at this level in 2024. Notably, the PCE price index, which the central bank uses as its inflation target, jumped 6.1% in January and the consumer price index rose by 7.9% in February. Both figures are annualized. Moreover, they do not coincide with the Fed's 2.0% target.

"If you want to tighten policy, you have to raise interest rates by more than inflation went up," Summers said. He believes the Fed should raise interest rates by more than 4 percentage points this year. However, it may not be sufficient. Summers also stated that most policymakers led by Chairman Jerome Powell still assumed that inflation would slow down in time. However, a professor at Harvard University believes that such factors as higher rents, supply chain problems and labor shortages will further prop up prices, leading to an increase in wages. "I don't think we can count on the transitory inflation view", Summers said. He also questioned the Fed's expectations that unemployment would remain at 3.5% in 2022, while inflation would fall dramatically in the meantime.

ECB

The European Central Bank also stated last week that it would pursue more aggressive policies to reduce inflationary pressures. However, ECB President Christine Lagarde played down fears about eurozone stagflation in her recent speech. She added that Russia's military operation in Ukraine had already exerted pressure on the economy, further stoking already-record gains in consumer prices.

On Monday, Lagarde reported at a conference in Paris that geopolitical tensions would have serious consequences for economic growth as inflation continued to accelerate and business and consumer confidence would be undermined. She said that difficulty for central banks was to maintain price stability without hurting business activity. As for stagflation, Lagarde noted that, "even in the bleakest scenario, with second-round effects, with a boycott of gas and petrol and a worsening of the war that goes on for a long time - even in those scenarios we have 2.3% growth. We are not seeing elements of stagnation now," she said.

Lagarde declined to discuss the ECB's stance on monetary policy. However, she conceded that the ECB would not move at the same pace as the US as the Federal Reserve started a cycle of interest rate hikes last week. She reiterated that the EU and the US were not in the same phase of the economic cycle. "We are in different universes, at a different stage in the cycle, with different starting points," Lagarde said. "We in the euro area are at negative rates, while the US never went below zero."

Technical picture of EUR/USD pair

Euro bulls did not manage to reach their target yesterday and decided to retreat. The geopolitical tensions between Russia and Ukraine are escalating. Therefore, there are little prospects for further strengthening of risky assets. Taking into account the Fed's aggressive monetary policy, the dollar will likely strengthen in the near term. It is advisable for euro buyers to return above 1.1010 to continue correction to the highs 1.1050 and 1.1090. The trading instrument's further decline will be followed by buying around 1.0950. However, the key support level remains at 1.0910.

Technical picture of GBP/USD pair

The British pound has already reached the support level of 1.3130. Moreover, bears are targeting to break it. Last week, the British pound was again in a weak position against the US dollar due to the Bank of England's dovish rhetoric. Now, the bulls need to defend their positions. The nearest major support is located in the areas of 1.3090 and 1.3040. Further bullish correction is possible only after the breakout above 1.3170, resulting in the pound's jump to the highs of 1.3210 and 1.3250.