The US rate hike – what does it mean for Ireland?

The backdrop

The outcome of the Fed’s policy meeting will be announced on Wednesday evening, but markets and analysts are expecting a quarter percentage point hike, bringing the US rate to 0.75 per cent, and a signal of two more increases next year.

Crucial is how fast the Fed plans to normalise interest rates, which have been on a setting close to zero since the crash, and also how policymakers think president-elect Donald Trump’s spending plans will impact growth and inflation, colloquially known as the dot plot.

Recent comments from Federal Open Market Committee (FOMC) members point to the Fed making few major adjustments until it has better clarity on Mr Trump's fiscal plans and the feasibility of them being passed by Congress.

But what does it mean for Ireland?

Interest rate hikes typically prompt an appreciation in the host currency as capital flows in to avail of better returns. This means the dollar would gain against the euro, making our exports relatively more competitive, further shoring up our bumper US trade. A stronger dollar has the potential to increase the buying power of US foreign direct investment, a central pillar of the Irish economic machine. In general, signals by the Fed that it intends to raise rates reflects its confidence in the health of the US economy – ultimately a good thing for

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Ireland

given its dependence on the US multinationals.

A potential spanner in the works

The big elephant in the room is, of course, Mr Trump and just what his election means for US economic policy.

His massive infrastructural spending plans could boost US growth and inflation temporarily, but they could also increase the US budget deficit and bump up the cost of borrowing, potentially damaging economic growth. This could potentially force the Fed into reverse on interest rates.

The Republican candidate made a lot of pledges during the election, many of which are unlikely to see the light of day. However, he has been strong on the need to reduce US corporation tax and provide a channel to reverse the offshoring of multinational profits, both of which could negatively impact the Irish economy.

Where is the ECB in all this?

Last week, the ECB extended its bond-buying programme longer than many had anticipated – albeit cutting the size of monthly government bond purchases – and predicted euro zone inflation would hit 1.7 per cent only by 2019.

The relatively dovish forecasts and cautious tone of policymakers has prompted a softening of the euro. The ECB may want to wait for the Fed decision before announcing a swifter tapering of its programme.

In conclusion?

Despite the uncertainty, it looks as if the long-awaited period of higher interest rates is beginning, however gingerly. When it finally arrives, it will only be a matter of time before Europe is forced to follow suit.

Higher interest rates will mean bigger borrowing costs for Government and for consumers in the form of higher rates charged on loans.

For variable rate mortgage holders especially, this is not something to look forward to.