The US Federal Reserve on Wednesday raised interest rates by 0.75 percentage points for the third time in a row this year, in an attempt to stamp out high inflation.
The move designed to reduce demand in the world’s largest economy will almost inevitably lead to falling stock prices, lower spending and less hiring in the labour market.
In the Cayman Islands, higher US interest rates make debt servicing more expensive. Local banks adjust their prime rate, or base lending rate, for US and CI dollar lending for mortgages and loans in line with changes to the US Federal Funds rate.
Higher rates for longer
The Fed adjusted its forecasts and is now predicting higher interest rates for longer.
As a result of the hike, the Fed Funds rate has reached a target range of 3% to 3.25%, already exceeding the US Central Bank’s May forecast for where it expected rates to be at the end of the year.
It is now expected to reach around 4% by the end of 2022 and peak even higher in 2023.
That implies the Fed will stay aggressive with at least one more 75 basis point rate rise at its next meeting in November.
The US central bank has set its so-called terminal rate at 4.6%. That is the rate at which the Fed expects to end its current tightening regime at the end of next year, before interest rates are projected to decline again to 3.9% in 2024 and 2.9% in 2025.
Higher unemployment, less growth
Fed officials were clear about the economic impact higher interest rates will have, stating they believe the US unemployment rate will rise from 3.7% this year to 4.4% in 2023 and 2024. At the same time US GDP growth is expected to slow to just 0.2% this year, followed by 1.2% in 2023.
These projections are much lower than the Fed’s June forecast but still higher than what many economists expect, who see the US economy sliding into a recession in 2023.
Federal Reserve Chair Jerome Powell told a press conference in Washington that officials were determined to curb inflation.
“We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%.”
Hinting at further rate hikes, he added, “we will keep at it until the job is done.”
US inflation peaked at 9.1% in June, but consumer prices remained stubbornly high at 8.3% in August.
Debt servicing becomes more expensive
In Cayman, the Fed’s rates outlook will translate into higher borrowing costs, in particular for homeowners, and potentially less debt-financed business investment.
The Federal Funds rate is the rate at which US banks borrow and lend to one another overnight. In the US and the Cayman Islands, variable interest loans and mortgages are typically pegged to the Fed Funds rate and priced as a margin on top of that rate. Any US interest rate increase therefore translates into higher loan interest and savings rates in Cayman for many financial products that are subject to floating interest rates.
Higher mortgage rates can be expected to put a chill on activity in the local property market as financing home purchases becomes more difficult. The higher debt servicing costs for borrowers, in turn, are likely to prompt banks to tighten their lending criteria.
Butterfield Bank on Wednesday announced that its US and CI dollar prime rates for residential mortgages, consumer loans and corporate loans will increase by 0.75% to 6.25%, effective 23 Sept.
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