The Federal Reserve climbed US interest rates by another 25 basis points – its third upward move since the financial crisis. Janet Yellen, chair of the Fed’s leading body of governors, said the economy is on a sound balance as unemployment is falling, thus rates need to go up to minimise the inflation. She anticipates that the central bank will increase rates twice more this year, quickening from the single rate raises in 2015 and 2016. She additionally specified that the rate rises will be steady and motioned ahead of time – and that it is fundamental to move rates upward to keep away from a blast and bust.
“Waiting too long to scale back some accommodation could potentially require us to raise rates rapidly some time down the road which in turn could risk disrupting financial markets and pushing the economy into recession,” Yellen stated. “The trajectory you see as the median in our projections which this year looks to a total of three increases, that certainly qualifies as gradual.”
Yellen believes that by doing so she is helping the country to achieve its goals and diminish unemployment, despite that there is no certain policy yet. As she mentioned: “We’ve not discussed in detail potential policy changes that could be put in place, and we’ve not tried to map out what our response could be to particular policy measures”. These goals could be achieved only if there was a raise of some interest rates, as it would stop the economy from increasing sharply, which would possibly lead to a recession.
“If interest rates are very high they attract money into the country because there’s money around in capital markets that chase interest rates,” Mr. Garry Carr, Senior Lecturer at Leeds Beckett Business School mentioned in an interview. “The country can use that money to invest”.
For some, the fact that the Trump administration decided to raise the interest rate is a sign of toughening policy, and though the markets have responded positively it remains to be seen if the investors will react the same way. More specifically, the dollar drops while euro increases to $1.0681. US short-term interest rate futures rise after Fed meeting and US stocks add to gains after Fed policy statement. “Rising US interest rates have also traditionally been viewed as bad news for emerging markets as higher US interest rates mean a strengthening of the dollar which depresses emerging market currencies, making it harder for these countries to service their debts which are typically denominated in USD. However, the start of a US interest rate tightening cycle can actually be good for emerging markets to the extent that it reflects a strengthening global economy”, mentioned Tom Stevenson, investment director for personal investing at Fidelity International in his interview at The Telegraph.
But that interest rate will not be the only one that the Fed is predicting. There will be another two rate hikes in 2017. The main projection noted by Ms Yellen argues the goal rate will rise to 1.4pc by the end of the year. “We’re closing in on our unemployment objective, we’re coming closer to the inflation objective, and as we reach them, particularly as we see the outlook as roughly balanced at this point, it looks to us to be appropriate to gradually raise the federal funds rate back in the direction of neutral,” Yellen maintains.
Economists are more sceptical, however, and believe the economy may grow less strongly. “The Fed looks unlikely to ‘take away the punchbowl’ from global growth any time soon” said Anna Stupnytska, global economist at Fidelity International.
But what does this situation really means for the global markets? Many countries across the world borrow money in dollars or try to lend to the US government in dollars. As a result, an interest raise of that of this magnitude would indicate a flow of funds into the US and an advance of the cost of borrowing. As Mr. Carr says “If a poor country borrows from America when interest rates are low, if America puts interest rates very high then that poor country’s economy is hurt quickly”.
A currency war is also possible, since the Trump government has already attacked China for devaluing its currency. Now all that is being done is to express the resentment for the Chinese currency situation, but that could also lead to additional fees on Chinese goods that would trigger a trade war.
Overall, Mr. Carr asserts: “Low interest rates have many different effects according to the people that we’re talking about. It’s good for countries that it makes the economy go faster but it affects countries which have already borrowed money and have to pay other countries back”.