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Explainer: Will the US Fed’s biggest interest rate hike since 1994 curb inflation and can it affect loans in S'pore?

SINGAPORE — The United States Federal Reserve (US Fed) on Wednesday (June 15) announced its largest interest rate increase since 1994, raising it by 0.75 percentage point.
People walk by the New York Stock Exchange on June 16, 2022 in New York City, a day after the Federal Reserve's largest rate hike since 1994.
People walk by the New York Stock Exchange on June 16, 2022 in New York City, a day after the Federal Reserve's largest rate hike since 1994.
  • The United States Federal Reserve announced on June 15 its largest interest rate increase since 1994
  • It raised the rate by 0.75 percentage point, on the heels of a similar move in May, in an effort to rein in raging inflation
  • However, economists in Singapore said the rate adjustments would only be effective to a certain extent
  • In Singapore, people may feel the impact of the US Fed's move since interest rates here track those in America

SINGAPORE — The United States Federal Reserve (US Fed) on Wednesday (June 15) announced its largest interest rate increase since 1994, raising it by 0.75 percentage point.

This follows a similar move just last month, when the central bank hiked the benchmark interest rate by 0.50 percentage point — the biggest increase in more than two decades — as it tries to keep in check inflation that has soared to 40-year highs.

Economists who spoke to TODAY said that although the hawkish move may heighten worries about a looming recession, another concern in the more immediate horizon for people in Singapore would be the impact it has on loan interest rates here.

This would include all forms of borrowing such as student loans and personal loans, as they are likely to track the US interest rates, though the economists differ on how immediately or closely the increase here would follow that in America.

WHY HAS THE FED HIKED INTEREST RATES, AGAIN?

Economists told TODAY that the central bank’s aggressive move is basically it “playing catch up” to inflation in the wake of the post-Covid economic recovery.

Mr Jonathan Koh, Asia economist at Standard Chartered bank, said: “The growth recovery in the US has also been strong, in part due to the huge amount of fiscal stimulus doled out during the pandemic.”

The recovery has led to a tight labour market and strong spending, pushing up prices.

Mr Song Seng Wun, a private bank economist at CIMB, said: “But (the Fed) and many other big developed economies continue to insist inflation was transitory and they left monetary policy at what we call a very accommodative level.

“Basically, the cheap money policy was left too long, well after the worst of the pandemic.” 

Raising interest rates would make the cost of borrowing money more expensive. This means consumers would be less likely to spend money. Businesses, too, will be discouraged from expanding operations, thus reducing the pressure on prices.

HOW EFFECTIVE WILL IT BE IN COMBATING INFLATION?

Elevating interest rates would help to dampen “some inflation because it’s demand driven to some extent”, but Mr Koh from StanChart noted that supply-side factors are also pushing up prices.

The economists pointed to the impact of the war in Ukraine on energy and commodity prices, as well as supply chain disruptions from the pandemic, as some of such factors.

Mr Eugene Leow, an exchange rates strategist at DBS bank, therefore said that the Fed's hike would not be as effective in achieving its intended aim of reining in inflation.

“Inflation might be sticky, heading down slowly.” 

The Fed aimed to bring down inflation rates to about 2 per cent, from the current 8.5 per cent.

Mr Kelvin Tay, regional chief investment officer at UBS Global Wealth Management, said on the other hand that it would be too early to judge the impact of the rate hike.

For example, it would take time before the rate adjustments affect businesses as well as the "overheated" and tight labour market there, which contributes to wage inflation.

WHAT ARE OTHER CENTRAL BANKS DOING?

Not all central banks are tightening their monetary policy as aggressively as the Fed in the midst of rising global inflationary pressures, the economists said.

For one, China is easing its policy as it was among the first to see economic recovery from the pandemic and among the first to slow down, Mr Tay said.

“So now they’re actually in the midst of easing policy to stimulate growth,” he added.

Ms Selena Ling, head of treasury and research at OCBC bank, said that the move by the Fed “also puts pressure on emerging market central banks as interest rate differentials may precipitate capital outflows”. 

“But (an emerging market central bank) typically tends to factor in growth prioritisation concerns as well, so they may not slam on the brakes as hard.” 

Maybank Kim Eng’s senior economist Chua Hak Bin said that central banks in Southeast Asia will speed up their timeline for policy normalisation in response to the US Fed's "despite the nascent economic recovery".

"Bank of Thailand may have to call for an emergency meeting and bring forward their plans for a rate hike rather than wait for almost two months until its next scheduled meeting on Aug 10," he said.

The Monetary Authority of Singapore (MAS), which uses the exchange rate instead of interest rate as its main tool, has already tightened its monetary policy in April this year — the third of such tightening in six months — to combat inflation.

WILL THE RATES HIKE HERALD A RECESSION?

Sharply increasing interest rates to dampen demand also increases the risk of a recession, the economists said, although they differed on the extent of the risks.

Mr Koh from StanChart, for example, quoted an assessment by the New York Federal Reserve, which said that the risk of a recession in 12 months’ time is less than 5 per cent.

However, Mr Koh added that the risk would increase if the US Fed continues on its aggressive path.

"We think a US Fed funds rate above 3.5 per cent will likely tip the US and Singapore into a recession," Mr Chua from Maybank Kim Eng projected.

Mr Song from CIMB said: “Just as the Fed has been slow (to raise interest rates), there is a risk of it being overly aggressive in tightening policies, which could trigger a recession.”

HOW WILL IT AFFECT LOANS IN SINGAPORE?

Since MAS does not control interest rates here, Singapore’s interest rates would follow US interest rates, Mr Koh said.

Ms Ling from OCBC said that this would include “most of the loan packages” here, when asked how the Fed rates may affect borrowing here such as car loans, personal loans and micro loans.

Mr Song from CIMB expects the changes to US Fed rates to reflect very quickly on interest rates for borrowing here, albeit with a slight variation in amount.

“Why are Singapore and US rates not one-to-one? They depend on other factors such as the overall cost of doing businesses in Singapore versus US as well as arbitrage costs,” he said, adding that the differences are relatively small.

Ms Ling said as well that she “expects increases (in Singapore) to be more muted since MAS is also tightening monetary policy”.

Related topics

MAS recession inflation Federal Reserve USA

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