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US Inflation has skyrocketed in January to 7.5%, recording the largest annual increase in 40 years. This jump in prices is the fastest pace of inflation since 1982.
Part of the Fed's job is to prevent inflation from getting out of control — and bring it back every time it rises to the bank's 2% target. To curb current inflation, the Fed plans to increase interest rates several times this year - possibly as many as five times.
Investors are waiting for the Fed to raise rates at its next March meeting. The question now is not whether the Fed will raise rates, but whether it the rate hike is by 50 basis points or 25 basis points.
How does raising interest rates curb inflation?
1. Higher interest rates reduce demand
The Federal Reserve controls the federal funds rate, which is often referred to as the target rate. It is also the rate banks use for providing overnight loans to each other. Banks borrow money to be able to deliver loans to consumers and businesses. Therefore, when the Fed hikes rates, it raises the cost of borrowing for banks that need money to lend to others or meet their regulatory requirements. Of course, banks pass these higher costs on to consumers and businesses. If the Fed raises the interest rate by 25 basis points or 0.25%, consumers and businesses will also have to pay more to borrow money.
As the cost of borrowing increases, demand and economic activity decline. For example, if a car loan becomes more expensive, you as a consumer may decide that now is not the time to buy that new car. Or, perhaps, a company is less likely to invest in a new factory and hire additional workers if the interest it has to pay to get a loan to finance its business increases. That is the cost to pay when the Fed raises rates.
2. Lower demand reduces inflation
Since raising rates lowers demand and puts the brakes on the economy, that's exactly what slows down inflation. Usually, the prices of goods and services rise when the demand for them increases, fuelling inflation. However, as borrowing becomes more expensive, the demand for goods and services decrease throughout the economy.
Prices may not necessarily decrease and return to their old rates after raising rates, but at least their inflationary rate will decrease. The Fed follows this cycle to control inflation. Inflation rises strongly, so the US central bank hikes rates until the demand for goods and services decreases, and thus prices calm down, and so does inflation. Will the Fed succeed this time?
Recently, for the first time in two decades, the euro reached parity with the US dollar…
The second earnings season of 2022 has almost begun. From banks and tech stocks to cars and the retail sector: in this outlook, we covered the most promising releases of this summer and made several projections on the companies’ prospects.
The stock market has reversed, and now it’s going lower and lower…
Last year was tough for the Japanese yen. USDJPY gained more than 30% over 2022, striking above 150 in October. While anticipation of slower Fed rate hikes pulled the pair below the 130 level at the start of 2023, the speculations over the destiny of BOJ’s yield control policy grabbed the attention of the Japanese assets in the middle of January. What lies ahead for traders of the Japanese yen?
Today, at 5:00 pm (GMT +2), the Bank of Canada will publish the Overnight Rate, which represents short-term interest rates, and is pivotal to the overall pricing of the Canadian Dollar in the global markets. Let's look at how the markets are faring ahead of the BoC rates release.
In a call scheduled for January 25, 00:30 am GMT+2, Microsoft will publish the company's earnings for the final quarter of 2022 and comment on the results, projections, and outlook for the nearest future of the company.
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