What is ‘The Fed’?
The Federal Reserve or ‘Fed’ is the central bank of the United States. It keeps a close eye on the US economy and steps in whenever inflation, employment levels and business production are not on track. The main tools the Fed has at its disposal include; raising and lowering interest rates, generating more money and regulating financial institutions.
Why would the Fed raise interest rates?
The Fed has kept interest rates low for some time now to encourage borrowing and spending. When people spend money, it promotes economic growth, which is all good until prices start rising (i.e. inflation). Inflation follows the ‘Goldilocks principle’: too much is just as bad as too little. So when things start getting expensive, the Fed tries to restore a bit of balance by increasing the cost of borrowing.
What is the new US interest rate?
Janet Yellen, the Fed’s matriarch, has said that “job gains have been solid in recent months and the unemployment rate has declined” but inflation had increased “considerably”, so she’s raised the benchmark interest rate by 0.25% to a range of 0.5%-0.75% to put the break on rising prices. This is only the second rate hike since the financial crisis in 2008.
What will this mean for UK investors?
A rate rise will mean that American savers get better returns and more often than not, will cause the dollar to strengthen, as foreigners move savings into Dollars. If this happens, companies making profits in dollars are also likely to see their share prices rise, giving US shares a real boost. However if rates continue to rise, investors may gravitate from shares into fixed income investments, because if you know you can get a good rate from a safe government bond, then why take the riskier stock options?
What will this mean for UK businesses?
A strong dollar and a weak pound is good news for UK exporters who will inevitably cash in on the difference but bad news for anyone importing supplies from the US. Furthermore, higher US interest rates are not going to get borrowers too excited, both in the US and here in the UK, due to the inevitable knock-on effect.
What happens next?
The Fed has suggested that there will be three other interest rates hikes next year and if this happens, then it may mean bond yields will continue to increase in the US and, to a lesser extent, in the UK. However Janet Yellen has suggested that there still remains a lot of uncertainty in the economy following the election. All eyes remain on Donald Trump now and, of course, his highly active Twitter account.
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