The European Central Bank (ECB) has hiked interest rates by 50 basis points for the first time in the past 11 years! I know you might be wondering, is an increase in interest rate a good news? Yes, it is. Let’s find out how.
What’s Happening?
Until now, the Federal Reserve of the US was raising interest rates. And with every rate hike in the US, India was raising interest rates too.
Let’s first understand why was India walking hand in hand with the US?
Assume there are two countries – ‘A’ and ‘B’ – with interest rates equal to 5%. The next day, country ‘A’ increases the interest rates by 50 basis points and their interest rate hikes from 5% to 5.5%. Now, because country ‘A’ offers a high-interest rate, money will flow from country ‘B’ to the country ‘A’.
So, every time the US hikes interest rates, there is a chance that the foreign money invested in India will flee to a country offering a high-interest rate. If this happens, it will cause pressure on the foreign reserves, which will weaken the Indian rupee.
This is why India made various conscious efforts to prevent the rupee from falling against the US dollar.
Usually, when a country increases interest rates, it attracts many foreign inflows, strengthening its currency. This is something that happened in the US.
With increasing interest rates, it attracted a considerable amount of foreign inflows; hence its US Dollar Index (DXY) saw a considerable upside.
If you are wondering what US DXY is, it is the index which measures the value of the United States Dollar relative to a basket of foreign currencies.
So, as DXY was rallying, it put pressure on emerging countries like India.
What Is The Equation Between USD and EUR?
The Euro area’s inflation in June 2022 was 8.6%, which was 1.9% a year earlier. Hence to tame inflation, the European Central Bank (ECB) announced a rate hike after 11 years.
Now, Euro and USD have barely been in equilibrium. Euro is always valued at more than 1 USD. But on 11th July 2022, the Euro and USD touched the equilibrium point of 1 USD=1 Euro.
After the European Central Bank (ECB) announced a rate hike, we have seen that the US dollar is facing tough competition against the Euro. Hence, the USD is falling, and Euro is strengthening. As of 25th July 2022, 1 Euro = 1.2 USD.
So, suppose the ECB keeps raising interest rates to control inflation. In that case, the USD will continue to face tough competition, which might fall further, providing ease to emerging countries like India.
What Lies Ahead?
As the Indian rupee has been internationalised, it is slowly gaining acceptance. Now, the rupee is accepted for transactions at all airports in Dubai.
The Monetary Policy Committee of India will meet again from the 3rd to the 5th of August 2022. Now, the outcome of the meeting will act as an important note for the markets.
That’s it for today.
I hope this article was insightful. Don’t forget to share this knowledge with your friends!
