The US central bank, the Fed, has raised interest rates as expected. In the fight against high inflation, the base interest rate has been raised from zero to 0.25 to 0.5 percent. The Fed is expected to raise interest rates further in small steps in the coming months. The last time the Fed raised interest rates was in 2018.
With the outbreak of the corona pandemic in March 2020, the Fed cut interest rates in two steps to zero percent and started a large-scale bailout program to protect the economy from a collapse. The US economy is now showing a strong recovery from the crisis and is struggling with sharply rising inflation. That's the highest inflation in more than 40 years, partly due to rising energy prices.
"Inflation remains well above our long-term target of 2 percent," Fed Chairman Powell said. “The rise in crude oil and other commodity prices as a result of the Russian invasion of Ukraine will put additional short-term upward pressure on inflation here with us.”
Powell expects interest rates to average 1.9 percent at the end of this year and to 2.8 percent in 2023. That is a lot higher than previously stated. Powell: "These expectations do not represent a decision or plan by the Fed and no one knows with any certainty where the economy will be a year from now."
Fed vs ECB
Unlike the Fed, the European Central Bank (ECB) has so far been unwilling to raise interest rates, despite skyrocketing inflation. According to the ECB, Europe's high inflation is largely the result of excessive oil and gas prices, combined with the war in Ukraine. Inflation is expected to fall again in the course of this year or next. In addition, Europe has to import most of its energy, while the US produces a lot of oil and gas itself.
Another indicator for interest rates is the labor market and wage developments. In the US, the tight labor market and inflation are pushing up wages and creating a wage-price spiral, something that has not yet really happened in Europe.
Bandwidth
By the way, the US uses a bandwidth of a quarter of a percent in the base interest rate. The interest is now at 0.25 to 0.5 percent. This is due to the economic differences in regions and states, which means that some regions benefit more from higher interest rates than others. Regions can therefore better coordinate interest rates.
The ECB base rate, on the other hand, is simply a percentage, although the eurozone is also made up of different economies with economically and financially strong(er) and weak(er) countries, which would also benefit from different interest rates. Germany and the Netherlands tolerate higher interest rates better than, for example, Italy or Greece. However, a range of interest rates in the euro countries could have a disruptive effect and trigger unwanted capital flows between countries.