The Federal Reserve (Fed) last week raised its benchmark interest rate to the 1.75–2 per cent bound. The hike was widely anticipated as the US central bank is looking to prevent the economy from overheating while inflationary pressure is rising. The core Consumer Price Index, measuring inflation and followed by the Fed, was at 2.2 per cent in May and above the central bank’s 2 per cent target.
The US S&P 500 reached a record valuation this January of 2,872.87. Despite a sharp sell-off in February, the stock market index is likely to continue to appreciate. Equity valuations, which are based on expected future earnings, have also risen following US President Donald Trump’s announcement of major tax cuts.
The prospect of lower taxes and loose monetary policy encouraged borrowing and spending not only among consumers but also businesses.
US unemployment reached its lowest level in almost 20 years in May, indicating the labour market is close to full capacity. This, in turn, means workers can now demand higher wages, which will boost consumer spending and drive up asset prices further.
The Fed is likely to act before price appreciation gets out of control though.
The Fed has previously suggested it will consider introducing two more rate hikes until the end of the year. So, considering the fact the initial interest rate rise had a positive impact on the value of the greenback, what will happen to the Dollar?
The recent Royal wedding in the UK is predicted to have provided a $1.4 billion boost to the British economy. Coupled with rising real wages, it is little wonder UK retail sales increased by 4.4 per cent in May on an annualised basis.
Across the channel, the European Central Bank has announced an end to its quantitative easing programme. A shift to tighter monetary policy will mean the single currency is likely to appreciate.
With that in mind, despite the Dollar’s stellar performance in the first half of 2018, the Pound and Euro are likely to strengthen against the US currency in the second half of the year.