The United States Federal Reserve’s monetary policy announcement was the much anticipated and highly sought event for the financial market participants last week.

Although, the rate hike was imminent and awaited, the market participants were rather eager to understand the projected path of the economy and whether the Fed was considering further gradual tightening.

The Federal Reserve on Wednesday June 13th, raised its benchmark interest rate for the seventh time since late 2015 and for the second time this year.

Their benchmark interest rate was increased by a quarter-point to two per cent.

Factors leading to the rate hike

A decade since the financial crisis, the Fed seems to be now well placed in attaining its policy objectives.

The borrowing costs were kept low after the financial crisis to encourage businesses and consumers to spend and grow the economy.

However, according to the Federal Reserve chairman Jerome Powell, their economic activity has been rising at a “solid rate”.

Their household spending had picked up, while business fixed investment had continued to grow strongly.

Their May unemployment rate was at its lowest since 2000 at 3.8 per cent, while U.S. payrolls expanded by more than 1 million workers in the first five months of 2018, reaching the milestone faster than in the previous two years.

Their inflation numbers too had been well in line to the Fed’s two per cent target range.

The U.S. personal consumption expenditures index, which is the Fed’s preferred price gauge of underlying price pressures, rose two per cent from a year earlier in March and April, after spending most of the past six years below it.

The core personal consumption expenditure index, which excludes food and energy, is forecasted to reach two per cent this year and 2.1 per cent in 2019 and 2020.

The Fed also revised its Gross Domestic Product growth forecast for this year to 2.8 per cent from 2.7 per cent.

With continued strengthening of the labour market conditions, stable increase in personal consumption expenditure, solid growth in economic activities, and recent signs of rising inflation, led the Federal Open Market Committee to raise the target range for the federal funds rate to 1.75 to two per cent.

What this means for the financial

market participants

A hike in benchmark interest rate of course has a bearing on the economy at large including growth, employment and inflation.

Fed fund rates are normally used as the benchmark that determines the level of almost all other interest rates and has a substantial effect on the value of the U.S. dollar.

Raising rates normally reduces inflationary pressure in the economy, which helps to make the dollar more valuable.

Higher interest rates also makes dollar-denominated assets more lucrative, attracting foreign investors.

This is turn raises the value of the dollar as these investors have to exchange their money into dollars in order to buy the investment assets.

Generally, higher interest rates mean that one has to paymore on the borrowings or rather earn a bit more on the savings or investment.

For borrowers on adjustable/variable rate loans or credits will eventually have to pay more on the amount they owe.

Whereas for people holding investments or deposits tend to earn a bit more as the interest rates are adjusted as per the benchmark rate.

The relevance of the rate hike to Fiji?

•  Fiji’s currency is pegged to a basket of currencies including the US Dollar. Therefore, any appreciation or depreciation of the US dollar due to adjustment in their interest rate, is expected to have a degree of correlation on the value of our Fiji Dollar.
•  Fiji’s USDollar denominated loan repayments become costly if the loans are on adjustable rates.
•  However, assets/investments held by the Fiji nationals in US denominations become attractive due to the increase in interest earned on the investment.
•  Any appreciation of the US dollar will make the import bills costly for our local buyers, as they would have to pay a bit more on their US dollar billed invoices.

Adjustment to interest rate is a Monetary Policy tool, which central banks use to manage inflation in the economy.

When the economy is overheating, the central banks would raise rates to bring back the inflation to sustainable levels.

When the interest rates are increased, it costs more to borrow.

So people tend to borrow less, and buy less.

That slows the economy and slows the pace of inflation.

Whereas in a sluggish economy, the interest rates are reduced to encourage more economic activity as when money is cheap and plentiful, there’s more demand and prices tend to rise.

However, rate hikes aren’t necessarily bad.

It is generally considered an indication that the economy is doing well, and pave the way for raises and a better return on your savings.

Feedback:  maraia.vula@fijisun.com.fj