The Federal Reserve raised interest rates on June 13 indicating a shift from the policies used to battle the 2007-2009 financial crisis and recession. In raising its benchmark overnight lending rate a quarter of a percentage point to a range of between 1.75 percent and 2 percent, the Federal Reserve dropped its pledge to keep rates low enough to stimulate the economy “for some time” and signaled it would tolerate above-target inflation at least through 2020. However, it is not the first time that the US has raised its interest rate in recent times. The Fed has raised rates seven times since late 2015 on the back of the US economy’s continuing expansion and solid job growth, rendering the language of its previous policy statements outdated. One of the reasons of recent hike is that inflation in the US is expected to be higher than projected earlier by the Federal Reserve. According to fresh projections from policymakers, it would run above the central bank’s 2 percent target, hitting 2.1 percent this year and remaining there through 2020.Also the Federal Reserve indicated that the need for near zero interest rate to buoy a crisis hit economy has lessened in view of strengthening labor market and rising economic activities. It also pointed out that household spending in the US has picked up while business fixed investment has continued to grow strongly. Fed Chairman Jerome Powell was latter to do a press conference to announce this policy changes.
The rate increase was in line with investors’ expectations and showed policymakers’ confidence in the economy’s growth prospects, continued low unemployment and steady inflation. The Fed now sees gross domestic product growing 2.8 percent this year, slightly higher than previously forecast, and dipping to 2.4 percent next year, unchanged from policymakers’ March projections. The unemployment rate is seen falling to 3.6 percent in 2018, compared to the 3.8 percent forecast in March.
The Fed’s short-term policy rate, a benchmark for a host of other borrowing costs, is now roughly equal to the rate of inflation, a breakthrough of sorts in the central bank’s battle in recent years to return monetary policy to a normal footing. Though rates are now roughly positive on an inflation-adjusted basis, the Fed still described its monetary policy as “accommodative,” with gradual rate increases likely warranted as a sturdy economy enters a 10th straight year of growth. Estimates of longer-run interest rates were unchanged and seen reaching as high as 3.4 percent in 2020 before dropping to 2.9 percent in the longer run.
United States of America is the e biggest economy by size (about $18 trillion GDP) and the biggest trading partner and investor for many other economies. It is the best investment destination for many investors. Keeping in view these factors any change in the in the US fiscal and monetary policies has marked effect on the flow of global trade and investment. The US is returning to normalcy with short-term rates moving up from the near-zero level in the post-2008 period to 1-1.25 per cent and further to 1.75 percent. The interest rate hike in the world’s largest economy has implications for emerging economies like India. The dollar inflows from foreign institutional investors (FIIs) have been robust in the past in India and other emerging economies due to troubles and uncertainties in the US. The focus on a normal monetary policy is now playing out well for the financial markets. There are expectations that a part of the money will flow back to the US as there will be investment safety and also good returns. The rupee value against the US dollar can also come under pressure if dollar funds’ outflow from the Indian markets take place. The rupee, which has strengthened a bit lately, came under pressure post the US Fed rate hike. The gradual hike in Fed rates will also make the international debt more expensive. If there would be narrowing of the interest rate differential between the US rates and the Indian interest rates it may impact the speculative or short-term money that comes to the domestic financial markets.