Monetary policies set by the European Central Bank and the Bank of Japan impact the Federal Reserve’s path of interest rates, according to a report Fed Chair Janet Yellen presented to U.S. lawmakers.

Policy divergence between the U.S., where the economic recovery is strong enough to warrant a gradual tightening of monetary policy, and Europe and Japan, where downside risks are prompting central banks to boost stimulus, have pushed up the dollar. That appreciation is damping U.S. exports and thereby economic growth, and also contributing to stabilization abroad, according to the Fed’s semiannual Monetary Policy Report published Wednesday.

“All else being equal, a smaller contribution to the U.S. economy from the external sector likely points to a more gradual pace of policy normalization in the United States,” the Fed said. “By the same token, the economic stimulus from more-depreciated currencies abroad may allow” foreign central banks “to provide less monetary accommodation -- or to start removing it earlier -- than would otherwise be the case.”

In her testimony to the House Financial Services Committee, Yellen kept the door open for an interest-rate increase in March. Her comments come less than two weeks after the BOJ Governor Haruhiko Kuroda unexpectedly adopted negative interest rates, with ECB President Mario Draghi also considering more easing.

Global Policy

“Recent monetary easing abroad likely has had a tempering effect on longer-term U.S. interest rates that partially offsets the effect of our own policy normalization,” the Fed said. “Analogously, reduced monetary accommodation in the United States likely will partially offset the effect of greater monetary accommodation abroad.”

Still, the implications of policy divergences for monetary spillovers shouldn’t be exaggerated, according to the report.

“U.S. policy remains accommodative and, on net, likely continues to contribute to accommodative conditions abroad,” the Fed said.

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