US inflation continued to go up in June, the consumer price index jumped 9.1% than a year ago. Prices are rising at the fastest pace in 41 years. Gas prices led the way up nearly 60% from the same time last year, energy prices increased by 41.6%, whereas, food prices continue to be sky high with meals at home costing families 12% more than last year.
The increase was largely driven by gas and energy prices which soured last month accompanied with a spike in rents not seen since the mid 80’s. Stock closed a bit lower on the news. All of this is leading to fear in the economy with Bank of America today forecasting a mild recession starting in the second half of the year.
Increase in cost of US products also means increase in cost of goods imported in India from the US. Imports like pulses, fuel, edible oils, etc. are affected by increase in global inflation. India being a net importer, has to pay huge bills for the import of crude oil.
To subjugate inflation, the Federal Bank will be hiking its interest rates through the year. Now considering high interest rates, investors will start withdrawing money from riskier investments. This will lead to more and more capital into US bank accounts as the investors will be attracted towards the USD due to which the Reserve Bank of India may be forced to increase its own interest rates in order to resist the fight of capital. This effect is termed as 'beggar-thy-neighbour effect'.
This situation puts the RBI into a dilemma as if it goes ahead and increases the interest rates then the economy will experience decreased money circulation which in turn will lead to appreciation of the currency making the exporters lose interest in exporting. Whereas if it doesn't then it will lead to increasing imported inflation and a fight of capital with the US.