The stickiness of US inflation has forced the market to drastically reduce expectations of interest rate cuts by the Federal Reserve, and has also had a widespread spillover effect on the monetary policies of central banks around the world.

On Thursday, Bank Indonesia unexpectedly announced an interest rate hike of 25 basis points, raising the benchmark interest rate to 6.25%, the first rate hike this year. Last month, Taiwan's central bank also unexpectedly raised the benchmark rediscount rate by 12.5 basis points to 2.00%.

James Knightley, chief international economist at Dutch International Group, said:

America's inflation woes have a global impact, and other central banks cannot ignore them. In particular, if the Federal Reserve is unable to cut interest rates quickly, it may cause the dollar to strengthen, thereby putting pressure on the European economy and limiting the ability of other central banks to cut interest rates. Furthermore, there are concerns that the US inflation situation may spread to Europe.

US inflationary pressure is spilling over the world

A series of recently released US inflation data shows that there is still a long way to go before inflation falls back to the Federal Reserve's 2% target line.

According to the March PCE data released last week, the Federal Reserve's preferred inflation target, the March core PCE price index after excluding food and energy was 2.82% year-on-year, with an expected 2.7% year-on-year growth rate. The previous revised value was 2.8%. On a three-month annualized basis, the core PCE price index jumped to 4.4%.

The Federal Reserve's protracted war against inflation has made it more difficult for other central banks to switch to easing. If other central banks cut interest rates more aggressively than the Federal Reserve, they may damage their own economies due to the effects of exchange rates, import costs, and inflation.

Taking the European Central Bank and the Bank of England as an example, the two central bank officials believe that they are not facing the same serious inflation problem as the US, which means they have more room to cut interest rates. Although investors expect the Federal Reserve to cut interest rates for the first time in November, senior ECB and Bank of England officials have hinted that they will cut interest rates this summer.

ECB President Lagarde said in Washington this month that the “roots and drivers” of inflation in the Eurozone and the US are different — Europe is more affected by energy costs, while the US is mainly affected by fiscal deficits. Bank of England Governor Andrew Bailey also believes that Europe's inflation dynamics are “somewhat different” from America's.

However, changes in the futures market show the global impact of the ongoing US inflation problem.

At the beginning of the year, when US inflation seemed to be on a downward trajectory, the market's interest rate cut expectations were also optimistic. However, the market currently expects the Bank of England to cut interest rates by 44 basis points this year, which is a sharp drop from 172 basis points at the beginning of the year and 56 basis points two weeks ago.

Nathan Sheets, Citigroup's chief economist, said:

If the Federal Reserve remains on the sidelines, it will be even more challenging for the ECB to cut interest rates drastically.

Marcelo Carvalho, head of global economics at BNP Paribas, also believes that the ECB is neither completely “dependent on the Federal Reserve” nor “unrelated to the Federal Reserve.”

Opinions within the ECB are divided between interest rate cutters and interest rate hikers

Looking at it now, there are differences within the ECB about the tolerance of the interest rate gap with the Federal Reserve.

Bank of France Governor François Villeroy said it is expected that interest rates will continue to be cut “at a pragmatic pace” after June. However, Bank of Austria Governor Robert Holtzman warned that it would be difficult to keep interest spreads too large with the Federal Reserve.

Since the beginning of the year, the euro has fallen 3% against the US dollar, only slightly above $1.07, but investors expect the euro to fall further to 1 compared to the US dollar.

According to the ECB's latest research, the currency depreciation scenario will cause inflation in the Eurozone to rise by about 0.3 percentage points within the next year. ECB Vice President Kinders said this week that the impact of exchange rate changes needs to be considered in the future.

However, some ECB officials believe that if the more hawkish US Federal Reserve causes a tightening of the global financial environment, it will instead increase the reasons for interest rate cuts in the Eurozone and other regions.

Bank of Italy Governor Fabio Panetta said on Thursday:

The tightening of US policies will have a negative impact on inflation and output in the Eurozone, which may strengthen rather than weaken the reason for interest rate cuts.

BNP Paribas estimates that if European bond yields are boosted by 0.5 percentage points due to the impact of the US market, the ECB will need to cut interest rates by an additional 0.2 percentage points to offset the impact of the tightening financial environment. Similarly, the Bank of England will need an additional 0.13 percentage point cut in interest rates.