US Fed hints at interest rate hike later this year
The US Federal Reserve has left interest rates unchanged at the moment, saying that US growth rates were currently high. The Chair of the Federal reserve Janet Yellen added that though there was a high growth rate, interest rate hikes could be needed to keep the economy from fuelling inflation. She stated that interest rate hikes could come by the end of 2016.
The US Federal funds rate is "the interest rate" at which depository institutions (banks and credit unions) actively trade balances held at the Federal Reserve (called federal funds) with each other, usually overnight, on an uncollateralized basis.
The 2007 global financial market turmoil led to a severe economic downturn. The US Federal Reserve responded to the recession by reducing the federal funds rate essentially to its lower bound of zero in Dec 2008, to stabilize the economy. In the ensuing seven years, the Federal reserve continued to maintain interest rates at near-zero levels, to increase employment rate and stabilize inflation.
The primary benefit of lowering interest rates is their stimulative effect on economic activity. Low interest rates increase public borrowing resulting in increased circulation of money. It also helps households and businesses finance new spending and help support the prices of many other assets, such as stocks and houses. Thus, low interest rates helps an economy's growth and improving employment.
An increase in Fed rate will raise the borrowing cost for carry trade (borrow from US and invest in India). Further, this may make US bonds and equities more attractive for investment for the investors looking for stable returns. This eventually is likely to result in funds flow out of both debt and equity markets of India, and put the rupee under pressure .
Economic Affairs Secretary Shaktikanta Das said that the government and RBI are prepared to deal with any eventuality arising out of the US Fed rate hike. The same sentiment was reflected by RBI governor Raghuram Rajan previously.
Speaking at the University of Massachusetts, the US Federal Reserve Chief, Janet Yellen said that she expected a hike in interest rates in 2015. She added that an increase in interest rate is likely as the inflation moves back to the objective of 2%. Yellen's remarks came a week after Fed's policymakers voted to keep its short term interest rates at near-zero.
The US dollar hit its highest in over five weeks against a basket of major currencies, a day after Federal Reserve Chair Janet Yellen said she expects rate hike in 2015, and after U.S. growth data appeared to support such a move.
The Federal Reserve increased interest rates by 0.25% after a near decade long lull, in a move that signals that the US economy may have healed after the 2008 recession. Recent trends indicated that the US job market was growing, prompting speculation that a rate hike was imminent. The Fed emphasized that the rate hike was a tentative beginning to a "gradual" tightening cycle.