High Inflation, The Fed Likely to Raise Interest Rates Again

The United States (US) government's policy of cutting taxes (corporate and individual) has had a positive impact on the US economy. As a result, the US economy has grown above 2% since the first quarter of 2017 (YoY). This economic expansion has also led to a rise in inflation, as shown in the graph below. This situation creates an opportunity for the US central bank (The Fed) to raise its benchmark interest rate again.

Based on the consensus among economists, the US central bank is expected to raise the Fed funds rate by 25 basis points (bps) to 2% at its meeting on June 12-13, 2018. This is supported by the fact that the US Gross Domestic Product (GDP) grew by 2.8% (YoY) in the first quarter of 2018, and the inflation rate in April reached 2.5% (YoY), exceeding the target of 2%. The high inflation rate increases the likelihood of the Fed raising its benchmark interest rate four times this year.

The improvement in the US macroeconomic conditions has also impacted global financial markets, including Indonesia. The rise in inflation has led to an increase in the yield on US Treasury bills, increasing the US government's financing needs and prompting the return of dollars to the American financial market. As a result, central banks worldwide are likely to follow suit and raise their interest rates to prevent capital flight, as Bank Indonesia did when it raised its benchmark interest rate by 50 bps in May 2018.