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The Fed Raises Interest Rates

Published on: 16/12/2016

This past Wednesday, December 14, the Federal Reserve stepped forward with a decision to increase interest rates in the United States from 0.25 to 0.50 with a promise of further increases in 2017. This was a long-awaited development that professionals in the financial market were expecting for many months, so this week we’d like to talk about its implications.

The Increase

The decision of the Federal Reserve, America’s central bank, arrived after a series of positive reports on the status of the US economy. While the economic climate in the States had been improving for over a year, it was last month’s presidential results – electing Donald Trump – that gave the dollar a further powerful push.

In practical terms, the costs of borrowing in the US will increase. Mortgages, student loans, credit card fees, among many others are likely to go up. To a certain extent rates have been very low since the economic crisis of 2008, but now they are set to go up. This will bring an increased appetite for investment in the US and make it an attractive destination for exports.

Dollar vs. Euro

A curious development is that the dollar right now is very well-positioned to approach parity with the euro. At 0.96 dollars for a euro, a level not reached since 2002, the two major currencies stand very close to one another in value and we have many reasons to believe the USD will keep getting stronger.

This would to a large extent be caused by the almost diametrically opposite stances on the regulatory banks in the States and in the European Union. In the US the Fed is pleased with the current economic data and expects further growth. A major contributing factor to this is that President-elect Donald Trump has promised to enact policies that develop infrastructure and manufacturing and seek to open new jobs for Americans, which would likely cause increases in inflation rates. To battle the rising inflation the Federal Reserve would need to keep increasing interest rates.

On the other side of the spectrum, the European Central Bank has been trying to encourage spending by stimulating the European economy with continuously lower interest rates. The ECB is going to continue this program well into 2017, so a further lowering of the euro can be expected. Furthermore, the European currency has seen some fluctuations due to political tensions on the continent, mostly UK’s decision to leave the EU and Italy’s recent referendum.

Financial experts now see it as a real possibility for the dollar to become fully equal to the euro in the coming year.

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