Rates finally increase but not much now and not too fast in the future either

The Fed has raised rates – finally some might say…

But does just a 0.25% rise in rates really matter?

An interest rate increase anywhere means:

  • Borrowing is more expensive –more expensive for business to raise money to invest or for consumers to fund house purchase or more general spending
  • Saving is less rewarding – a lot of older people feel increasingly resentful about this

But these are the obvious issues – there are many less obvious effects…

There are trillions of dollars sloshing around the world economy looking for return. When interest rates go up somewhere that jurisdiction becomes more attractive and money flows into its currency. The increasing demand drives up currency values. So here more people want dollars and the value of the dollar rises against all other currencies…

What that means is that US goods become more expensive in foreign markets making it easier for other economies to compete in the US; but harder for the US to export – which is why a rate rise has been resisted for so long. But it also makes the goods of those selling to the states cheaper against the dollar which means it becomes easier to export into the states. This is a part of the reason the fed has been under so much pressure from other, particularly Asian, countries to raise rates to give them more chance to sell to America…

In broad terms decreasing rates increases economic activity increasing rates will tend to slow down economic activity.

So the fed has been between a rock and a hard place. The US economy is doing better but is far from completely out of the woods – is it doing well enough now to support that rate rise. The Fed says yes.

The big question in the UK is will we slavishly follow suit? Mark Carney Bank of England governor says not. Most UK analysts, myself amongst them still think UK rates will not rise until at least the middle of next year (2016).

The pound does not face as much pressure to as the dollar and a rate rise would certainly hurt our exports. But conversely we are starting to see signs of UK property price rises and the UK employment figures are currently the best ever.

To hear more about this you can catch Simon on Money Talk.

If you would like to hear Simon’s take on the great EU debate, please listen here.

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