US Federal Reserve Raises Interest Rates to Combat Inflation Fears

Strategic Insights -

The US Federal Reserve Board increased short-term interest rates by half a percentage point in an effort to combat inflation at a time when rising prices are more a concern than a reality in the US economy. The move, which was met with a 23-basis-point increase in the Bank of Canada rate, was seen as a strong pre-emptive move against inflation and a positive for Canada. Canadian financial markets reacted with a sigh of relief as the uncertainty surrounding interest rates was put to rest.

Key Takeaways:

  • The US Federal Reserve raised short-term interest rates by half a percentage point to 4.75% to combat inflation fears, marking the fifth rate increase this year.
  • The rate hike triggered a 23-basis-point increase in the Bank of Canada rate, the first jump in eight weeks.
  • Canadian financial markets viewed the move as a strong pre-emptive action against inflation, with Andrew Pyle, chief Canadian economist for MMS International, stating, "We import any inflation they have south of the border."
  • Ruth Getter, senior vice-president and chief economist at Toronto-Dominion Bank, said, "Everybody is breathing a sigh of relief now that the uncertainty is over" concerning interest rates.
  • The sector most vulnerable to higher interest rates is U.S. housing construction, with Tommy Thompson, president of the National Association of Home Builders, warning that the Fed's rate hike could reverse the trend.
  • Despite the rate hike, the US economy is expected to continue growing, with industry operating at 84% of capacity for the past two months and the economy edging close to full employment levels.
  • The Fed's strategy is to slow economic growth to allow for productivity gains rather than volatile price hikes, with Carol Stone, senior economist with Nomura Securities International Inc., stating, "The Fed's strategy could work, and we could have a very moderate period of long-term growth."

Statistics:

  • Half a percentage point increase in the US Federal Reserve's benchmark federal funds rate, raising it to 4.75% from 4.25.
  • 23-basis-point increase in the Bank of Canada rate, the first jump in eight weeks.
  • 4.7% growth in US housing starts in July, nearly twice the expected rate.
  • 84% of US industry operating at capacity for the past two months.
  • 84,784.57 Dow Jones industrial average as of yesterday's close.
  • 3,784.57 Dow Jones industrial average as of yesterday's close.
  • US government 30-year bonds up 1 17/32 at 61 15/32.

Sources:

  • JACQUIE McNISH and MARIAN STINSON, The Globe and Mail
  • Andrew Pyle, chief Canadian economist for MMS International
  • Ruth Getter, senior vice-president and chief economist at Toronto-Dominion Bank
  • Tommy Thompson, president of the National Association of Home Builders
  • Carol Stone, senior economist with Nomura Securities International Inc.
  • David Shulman, equity strategist with Salomon Brothers Inc. in New York
  • Paul Kasriel, economist with Northern Trust Co. in Chicago
  • Commerce Department
  • US Federal Reserve Board statement