The ripple effect of US Fed’s rate hike

Against a global economic backdrop marked by geopolitical shocks, trade uncertainty and persistent inflationary pressures, the Federal Open Market Committee raised the federal funds target range by 25 basis points at its Sept. 16 meeting, to 3.75-4 percent. The move was the Federal Reserve’s first rate increase since July 2023.

At first glance, the decision may appear surprising given the resilience of the US economy. The median FOMC projection puts real gross domestic product growth at 2.3 percent this year and 2.4 percent next year, while the unemployment rate is projected to remain at 4.1 percent through 2027.

Domestic spending has remained resilient, supported by strong productivity growth and robust capital investment. Job gains have kept pace with workforce growth, while the unemployment rate has remained relatively low. The Fed’s latest statement also pointed to resilient domestic spending, strong productivity and capital investment, and little change in unemployment.

These conditions suggest that the employment side of the Fed’s dual mandate remains comparatively solid, reducing the immediate risk that tighter monetary policy will produce a sharp deterioration in labor-market conditions.

The more pressing concern is inflation. The latest available data showed US consumer prices rising 3.4 percent over the 12 months to August, while core CPI, which excludes food and energy, increased 2.4 percent. Producer prices also remained elevated, with the producer price index for final demand rising 5.4 percent over the year to August.

The Fed’s own September projections reinforce the persistence of inflationary pressure. The median forecast puts headline personal consumption expenditures inflation at 3.7 percent in 2026, before easing to 2.3 percent in 2027 and 2 percent in 2028. Core PCE inflation is projected at 3.4 percent this year, declining to 2.5 percent next year.

Taken together, these indicators help explain the Fed’s decision. While economic activity remains solid, inflation is still well above the central bank’s 2 percent objective. The FOMC said its latest action was intended to support a more timely return to that goal.

Yet the consequences of higher US interest rates extend well beyond the fight against inflation. Domestically, tighter monetary policy raises borrowing costs across the financial system, affecting consumer credit, mortgages, corporate loans and bond financing. Higher Treasury yields can also lift discount rates used to value equities and other financial assets, potentially putting pressure on asset prices and investors’ appetite for risk.

The transmission does not stop at US borders. Because the dollar is the world’s dominant reserve, trading and financing currency, changes in US interest rates influence global capital flows and borrowing conditions. Economies and companies that borrow in dollars can face higher debt-servicing and refinancing costs, while higher US yields can make dollar-denominated assets more attractive to international investors.

These dynamics can tighten global financial conditions, encourage capital to flow toward US assets, strengthen the dollar and place additional pressure on economies with significant external financing needs.

The impact is particularly relevant for countries whose currencies are pegged to the US dollar. In such economies, maintaining monetary alignment with the Federal Reserve can help preserve exchange-rate and monetary stability, although it can also transmit tighter financial conditions to domestic borrowers.

Saudi Arabia is a case in point. Following the Fed’s decision, the Saudi Central Bank, known as SAMA, raised its repo rate by 25 basis points to 4.5 percent and its reverse repo rate by the same amount to 4 percent. SAMA said the move was in line with its mandate to preserve monetary stability.

For Saudi Arabia, maintaining broadly aligned interest rate conditions with the US supports the stability of the riyal’s dollar peg and helps limit pressures on domestic financial markets. At the same time, higher rates increase the cost of borrowing for households and businesses.

The effects can therefore extend to consumer spending, mortgages, corporate borrowing and project financing. Higher financing costs may influence investment decisions and real estate activity, particularly for projects that depend heavily on debt financing.

For the wider Gulf Cooperation Council region, the Fed’s policy direction also matters because several economies maintain dollar pegs or closely managed exchange-rate regimes. Changes in US monetary policy can consequently have a significant bearing on domestic liquidity, borrowing costs and financial market conditions across the region.

Ultimately, the Fed’s latest rate increase reflects the difficult balance between bringing inflation back toward its 2 percent objective and preserving economic momentum. The resilience of the US economy has given policymakers room to tighten policy, but the resulting increase in borrowing costs will inevitably affect households, businesses and financial markets.

For Saudi Arabia and other dollar-linked economies, the trade-off is equally important. Monetary alignment with the Fed can support exchange-rate and financial stability, but it also transmits tighter credit conditions to domestic economies.

The broader economic impact will depend on how quickly inflation moderates and how households, businesses and financial markets absorb higher financing costs. The Fed’s decision therefore represents more than a US monetary-policy adjustment: it is another reminder of how closely global financial conditions remain tied to the policy choices of the world’s largest economy.