The US Federal Reserve raised the benchmark interest by 0.25% this week, marking the second increase in the rate in the last three months. In a Hawkish policy statement Fed chair Janet Yellen stated that the labour market strengthened in May, while the overall economy has been rising at a moderate pace this year.
In addition, the Fed noted that household spending has been on the rise and business fixed investment is expanding. A decline in inflation below 2% also played into the decision to raise rates. Federal Reserve policy makers agreed to one more rate hike in 2017 based on the current outlook.
The Fed also laid out detail in how they intend to shrink their $4.25 trillion portfolio of Treasury bonds and mortgage-backed securities, most which were purchased in the wake of the 2007-2009 financial crisis and recession. It expects to begin the normalisation of its balance sheet this year, gradually ramping up the pace. The plan, which would feature halting reinvestments of ever-larger amounts of maturing securities, did not specify the overall size of the reduction.
The US Central Bank’s rate-setting committee also said the economy had continued to strengthen with job gains remaining solid and indicated it viewed recent softness in inflation as largely transitory.
The financial markets reaction saw US stocks selling off with the US dollar index strengthening against a basket of currencies after the Fed’s rate increase and policy statement, as Janet Yellen indicated further rate hikes in 2017 and 2018 remained likely.
The euro fell to a weekly trading low of 1.1132, as traders considered the new rate differential between the euro and the US dollar, with the EURUSD initially moving to a seven month trading high of 1.1296 on Wednesday, as US inflation and retail sales data came in weaker than expected before the Federal Reserve chair Janet Yellen’s hawkish policy meeting comments. The US dollar also moved higher during the week against the Swiss franc and Japanese yen, with commodity currencies recovering losses against the US dollar as the week ended.
The Bank of Japan decided to kept interest rates unchanged and maintained the current expansionary monetary policy. The BOJ pledged to increase purchases at an annual pace of around 80 trillion Japanese yen, and maintained the short-term interest rate target at -0.1%. Japanese policy makers also kept the current economic assessment unchanged, noting the economy has been turning toward a moderate expansion.
Bank of Japan Governor Haruhiko Kuroda delivered a dovish press conference following the interest rate decision, in which he stated higher interest rates in the United States does not mean higher rates in Japan, and he also stated that inflation still remains below the band of Japan’s overall target.
The Bank of England kept interest rates at a record low of 0.25% at the June policy meeting, with the Quantitative Easing programme remaining capped at 435 billion pounds, despite the surge in the rate of inflation to its highest level since mid-2013.
The main surprise came from the Monetary Policy Committee who voted 5-3 in favour of holding interest rates at their current level, financial markets had been expecting at 7-1 vote in favour of holding rates unchanged. The MPC members who vote for a hike were the outgoing Kristin Forbes, as well as Ian McCafferty and Michael Saunders.
The British pound moved sharply higher on the news, moving towards the 1.2800 level, as traders priced in a possible rate hike in 2017.
The Canadian dollar rallied sharply this week, as hawkish comments from Bank of Canada deputy governor moved the USDCAD to a multi-month trading low. The USDCAD fell to a weekly low of $1.3160, as Carolyn Wilkins remarks about the pace of economic growth caused the Canadian dollar to strengthen. BOC governor Stephen Poloz reinforced her remarks with hawkish statements stating that the next move would be a rate rise rather than a cut.