US Fed likely to hike interest rate on Wednesday

New York: Market expectations of an interest rate hike by the US Federal Reserve later on Wednesday have heightened sharply following strong employment data released last week.

US Labor Department data on Friday showed that total non-farm payroll employment in the country increased by 235,000 in February. The unemployment rate was little changed at 4.7 per cent.

Earlier this month, US Federal Reserve chairperson Janet Yellen had signalled that an interest rate hike in this month`s monetary policy will likely be appropriate, if the economy progresses in line with official expectations.

"With the job market strengthening and inflation rising toward our target, the median assessment of FOMC participants as of last December was that a cumulative 3/4 percentage point increase in the target range for the federal funds rate would likely be appropriate over the course of this year," Yellen said in a speech at the Executives` Club of Chicago.

She also warned that waiting too long to raise interest rates could force the American central bank to act quickly in response to economic risks, which in turn could risk disrupting financial markets and pushing the economy into recession.

At its January meeting, the US central bank had left the benchmark interest rates unchanged, while offering a relatively upbeat picture for the economy. 

"Labour market continued to strengthen and... economic activity has continued to expand at a moderate pace," a Fed statement said after the policy meeting.

It also acknowledged the improved consumer and business sentiment following the election of Donald Trump as US President.

Last December, the Fed increased its key interest rate by 25 basis points in the first rate hike in 2016 and just the second in a decade. The first was in December 2015.

According to analysts, a Fed rate hike could set off capital outflows from emerging market economies like India with large external funding needs and macro-economic imbalances, thereby increasing their vulnerability. 

"While the impact of the rate increase on the US economy will be negligible, emerging market economies with large external funding needs and macro-economic imbalances could be vulnerable to capital outflows," Moody`s Investors Service has said in a report.

"The most direct impact will be felt in those economies that have high external financing needs relative to their foreign exchange earnings and reserves," the report said. 

The American agency said the spillover effect of the rate hike may manifest itself in different ways. 

"For instance, in some cases a pronounced currency depreciation could lead to higher inflation, which, along with the threat of sustained capital outflows, could force central banks to raise interest rates," it said. 

"The Fed`s tightening could have negative spillovers for those with large external funding needs, high leverage, macroeconomic imbalances, or uncertainties around politics and policies," it added. 

The Federal Reserve slashed rates to zero in 2008 in the wake the financial crisis and kept it at that level throughout the period of major economic slowdown that followed. 

In this connection, when previous Reserve Bank of India Governor Raghuram Rajan took charge at the RBI in 2013, at a time the US Federal Reserve had declared its intent to wind down its stimulus programme, the rupee plunged in value in respect of the US dollar on fears about a spiralling current account deficit.

In a series of measures, Rajan managed to stabilise the currency that also brought back investors.

India is currently seen as being better equipped than other emerging markets to ride the impact of higher US interest rates because of its stronger economic growth and impressive foreign exchange reserves of more than $300 billion.