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US Federal Reserve announced (December 16, 2015) that interest rates are to rise by 0.25 percentage points, the first rate rise since since 2006. At the same time it revised upwards its forecast for US growth, from 2.3% to 2.4%. Higher consumer spending and a stronger housing market were cited as the main reason for the rate rise. The move had been widely expected, and factored into recent decisions by traders and analysts.
The Federal Open Market Committe (FOMC) indicated that it was reasonally confident that inflation will climb back to its target range of 2% over the medium term. It noted that gradual increases in rates would be sufficient to dampen inflationary pressure and keep it near to the 2% inflation objective.
Despite the predictions of many, eight of the nine members of the Federal Open Market Committee (FOMC) decided to keep interest rates on hold. Despite the relative strength of the US economy, there are clearly major concerns about the weakness of the global economy in general, and the recent turbulence in China in particular. The FOMC supported its decision to keep rates on hold by stating that household spending and business fixed investment have been increasing moderately, and the housing sector has improved further; however, net exports have been soft.
This is confirmation that the US economy, like all other industrialised economies, is increasingly part of the global trading system and is, therefore, increasing affected by what happens outside of the US. Gone are the days when US economic policy could focus exclusively on changes in the domestic economy. Given that the FOMC has a statutory mandate to seek to ‘foster maximum employment and price stability’, pressure for a rate rise will come if either inflation nudges up to 2% from its current level of 1.2%, or if the labour market shows further signs of tightening. This means that if unemployment drops any further from its current seven-year low of 5.1%, the next move in rates is likely to be upwards. Exactly when that comes in October or November, or is delayed until 2016, is uncertain It is likely that the committee will wait for further confirmation that inflationary pressure is increasing.
While the US economy is currently in good shape, the general view is that growth will moderate through 2016. Much depends on whether oil prices will nudge back up as well as the outlook for the dollar. A continued strong dollar and weak oil prices will keep inflation well below target. The Fed has confirmed that only when it is confident that inflation will rise will rates head upwards. Perhaps it should be no surprise that rates are kept on hold again, given that they have remained unchanged since 2006 - the year that Ben Bernanke took over from Alan Greenspan as Chairman of the Federal Reserve.
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