Does the US interest rate influence the UK? -
interest rate affect

Does the US interest rate influence the UK?

Over the past couple of decades, there has been a lot of fluctuation in interest rate movement in the UK. From the high-interest rates seen several decades ago to the historic interest rate lows seen in the early 2020s during the Covid-19 pandemic, it has been a rollercoaster ride. Of course, there has also been a lot of movement with interest rates in other countries, and we’ve seen central banks such as the Fed implementing interest rate hikes and cuts over recent years.

Many people are keen to know whether US interest rate movements from the Federal Reserve influence the UK. All central banks must take action as part of their monetary policy strategy to tackle issues such as inflation or economic slowdowns. Sometimes an interest rate increase or decrease can be minimal. At other times, they can be steep.

As we know, interest rate movements in the UK can impact everything from the housing and financial markets to household finances, which can suffer when the interest rate rises. But what happens when Fed officials drop or raise rates? Naturally, this is something that will have an impact on the US economy and stock markets, but does it also influence the UK?

How does the US interest rate affect the UK?

It is essential to remember that any changes in the US interest rate can impact the global economy. After all, America is the world’s largest economy. So whenever the Fed chair, Jerome Powell, announces changes in the interest rate, it causes a flurry of speculation among economists in the UK and many other countries.

Of course, changes in the US interest rate will impact the effective federal funds rate, the labour market in the USA, the cost of borrowing such as credit card borrowing and loans, and more. It can also pressure other central banks to revise their interest rates, with policymakers carefully keeping an eye on rate increases and drops implemented by the US Treasury.

interest rate affect

This has been seen regularly between the start of 2022 and the beginning of 2023 as central banks battle to bring inflation down to target rates. Economists and industry experts have said there is no official connection between the US and the UK regarding interest rates. However, as a general rule of thumb, many believe that when the Fed changes interest rates, the UK will be close behind. This is because US interest rate changes will often pressure the UK’s Monetary Policy Committee to follow suit. This is why we often see changes in the UK’s base rate on the back of changes from the Federal Reserve.  

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Typically, the Bank of England follows the lead of the US Federal Reserve, according to the Financial Times. So, the impact on the UK is significant as it can affect mortgage rates, exchange rates, GDP, inflation, borrowing costs, and the economy as a whole.

In a nutshell, when the Federal Open Market Committee (FOMC) makes vital decisions about monetary policy in the USA, it can lead to interest rate changes from the Federal Reserve Committee. This leads to monetary policy action being taken by other central banks, including the Bank of England. This is why many people keep tabs on interest rate movements in the United States, as it often gives them an idea of what to expect in the UK.

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Cooling the economy and lowering inflation

Of course, the Federal Reserve Committee can reduce or increase interest rates based on various factors. The same goes for all decision-makers at all other global central banks. When the Federal Reserve Bank of New York decides to hike rates, it can significantly impact the nation’s financial markets, affecting businesses and investors, as well as individuals and households.

Since Joe Biden became President, interest rates in the USA have rocketed because of soaring inflation. The level of inflation has risen due to sky-high energy costs stemming from the Russian war against Ukraine and rising food costs, among other factors. By raising interest rates, the Federal Reserve aims to cool the economy by increasing borrowing costs and reducing disposable income. This can then help to bring inflation down.

The UK has the same goals to achieve, which is why the Bank of England has increased interest rates significantly between the end of 2021 and the end of 2022. More often than not, we have seen the Federal Reserve increase its base rate, and this has been swiftly followed by similar action in the UK.  

Bank of England

Attracting investment and impact on the dollar

Another way rising interest rates in America can impact the UK – and other countries – is by attracting more investments. When interest rates increase in the US, the returns on investments and savings improve. This can lead to investors gravitating toward the US to do business rather than investing in the UK or other countries where the returns might not be as good. It also impacts emerging markets that might have taken on a lot of cheap debt over the years but are then faced with soaring costs.

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Rising interest rates in the US also mean the dollar strengthens, which can pose problems for businesses and consumers in the UK. For companies, it can lead to a rise in the cost of importing goods and services if they deal with supply chains in the United States. This can lead to higher prices being passed on to consumers in the UK, which adds to the cost-of-living crisis and affects consumer demand. But, on the other hand, it could benefit some businesses that export to America, as this becomes cheaper for them, saving them money.

The strong dollar can also have a positive impact on certain workers in the UK, such as freelancers. If they deal with companies in the United States and receive payment for their services in dollars, they will be left with more money once it has been exchanged for GBP than they would have if the dollar were weak.

The good and the bad

So, as we can see, there is a significant impact on the UK when the US changes interest rates, even though there is no official link between the two. The effect can be negative in some respects but positive in others, so the UK has to deal with the good and the bad of interest rate movements in the United States. The impact can be seen in all areas of society, from businesses and freelancers to individuals and households. In addition, it can significantly affect many areas of the financial markets and the housing market due to changes in the UK interest rate.