Fed Raises Interest Rates to 22-Year High

Key Takeaways

• The US Federal Reserve raised interest rates to 5.5%, the highest in 22 years, due to a decline in inflation to 2.97%, but it still falls short of the 2% target.
• Europe is closely observing the US's interest rate actions, with the Bank of England potentially increasing its base rate to 5.25%, while the European Central Bank has also raised interest rates to a record high of 3.75%.
• The impact of the increased interest rate in the US includes higher average mortgage rates, increased credit rejection rates, and higher automobile loan costs, leading to economic uncertainty for many.

Fed Raises Interest Rates to 5.5%

The Fed has raised interest rates to the highest levels in 22 years, given the decline in inflation to 2.97%; however, it still lags behind the 2% monetary policy target.

On Wednesday, July 28th, 2023, the US Federal Reserve made the executive decision to increase interest rates by 0.25 percentage points, bringing the range from 5.25% to 5.5%. This move comes after the Fed had previously opted not to raise interest rates in May's review, which marked the first time they refrained from doing so after implementing 10 consecutive increases. The decision was influenced by a decline in inflation from 4.9% to 4.1%.

Figure 1 - Monthly 12-month inflation rate in the United States from June 2022 to June 2023

The interest rate increase becomes even more intriguing considering that inflation had dropped even further from 4.1% seen in May to a mere 2.97% in June. This sharp decline in inflation adds an extra layer of interest to the situation. Over the course of 12 months, US inflation has seen a significant decline, plummeting from 9% to 2.97%, coinciding with a continuous decrease in interest rates. This remarkable development aligns with the Federal Reserve's target of a 2% inflation rate, as they had previously emphasised the value of this percentage, stating:

"An inflation target of 2% is considered the sweet spot for maintaining a healthy economy" -  Federal Reserve

Eleventh Increase Since March 2022

In July 2023, the interest rate increase marked the eleventh time the US interest rates had been raised since March 2022, when they were increased by 0.25 percentage points from 0.25% to 0.50%. Currently, the US interest rates have reached 5.50%, and Fed Chairman Jerome Powell stated that he would assess the situation meeting by meeting. He refused to rule out the possibility of further interest rate hikes if future data indicated the need for it. The next meeting, scheduled for September 2023, will be crucial in making any such decisions.

Figure 2 - Fed Rates Hikes 2022-23: Battle Against Inflation

What Impact Has the Increased Interest Rate Had on the US?

As one can expect, an increase in interest rates often leads to economic uncertainty for a significant portion of the population. The scenario of eleven increases since March 2022 represents a substantial change from the zero interest rate observed in March 2020 and December 2008 in the US.

These are the changes since interest rates rose to 5.5%

• Average US mortgage rates - 7% (Highest level since November 2022)
• Credit rejection rate - 21.8% (Highest level since June 2018)
• Automobile Loans - 14.2% from 9.1% in February 2023

Cost of living in the United States - Distribution of Expenses

This data was obtained through Numbeo, an online database founded in Serbia. The database relies on cost of living metrics such as consumer prices, real property prices, and quality of life metrics. The information provided is valid as of July 2023 in the United States.

• Rent Per Month - 36.6%
• Markets - 28.8%
• Restaurants - 13.7%
• Transportation - 7.8%
• Monthly Utilities - 7.4%
• Sports And Leisure - 4.1%
• Clothing And Shoes - 1.7%

Can Europe Expect Further Interest Rate Increases?

With the recent decision to raise interest rates in the US, Europe is now anticipating their central bank meetings to determine whether they will follow a similar path in implementing further interest rate hikes to address inflation. As of June 2023, the current inflation rate in the United Kingdom stands at 7.9%, showing a decline from the previous rate of 8.7%. This drop followed a 0.50 percentage point increase in June, which was a response to the inflation data from May indicating that inflation remained at 8.7%, the same as in April, despite implementing a 0.25 percentage point increase from 4.25% to 4.5%.

On August 3, the Bank of England is set to increase its base rate by a quarter-point to 5.25%, resulting in the highest borrowing costs since early 2008. Additionally, there are rumors that the bank plans to implement two more rate hikes by the year-end, potentially pushing the interest rate to 5.75%, in response to ongoing price pressures.

Moreover, the European Central Bank has recently increased interest rates to a record high of 3.75%, following a 0.25 percentage point hike. This places the eurozone interest rate at its highest level since 2001, during a time when efforts were made to strengthen the value of the newly launched euro.

Gold as Hedge Against Inflation

Gold investing offers an advantage by serving as a hedge against inflation, as its price tends to rise when the cost of living increases. Inflation denotes the overall rise in the prices of goods and services, resulting in a reduction in the purchasing power of currency.

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