Last week, the US Federal Reserve (Fed), the country’s central bank, reduced the benchmark interest rate by 50basis points to 4.875 per cent, well within the Fed’s target range of 4.75 – 5 per cent.
The rate cut, a first in four years, was in response to months of easing inflation and meant to ward off a slowdown in the labour market.
According to the U.S. Bureau of Labour Statistics, the unemployment rate stood at 4.2 per cent in August 2024,with 7.1 million Americans without work. This was an increase from 3.8 per cent, with 6.3 million Americans without jobs in 2023.
The Fed’s interest rate decisions (hikes or cuts) always set off a chain reaction in different markets globally, including African markets.
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According to Churchill Ogutu, an economist at Kenya-based IC Group, the recent decision by the Fed did not come as a surprise.
"The Fed rate cut was not a surprise to the markets. With the easing of inflation, this policy direction was expected,” Ogutu told The New Times, adding that what surprised many was the magnitude of the rate trim.
The U.S. is not the only country experiencing a decreased rate of inflation. Closer home, countries in the East African region have also seen inflation easing up, with central banks in the region responding with rate cuts.
The National Bank of Rwanda (NBR) slashed its key repo rate by 50 basis points to 6.5 per cent in August 2024. Similarly, the central banks in Kenya and Uganda had a 25 basis points rate cut in August on the back of the disinflation trend.
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According to Bob Karina, Founder and Chairman of Faida Investment Bank, the recent rate cut by the Fed spells some good news for East African countries.
"The recent Fed rate cut can lead to lower borrowing costs for East African countries, encouraging more investments and consumption. A decrease in U.S. interest rates typically results in a weaker dollar, which can strengthen local currencies, making imports cheaper," Karina said, adding that the move could also boost equity markets as investors seek higher returns in riskier assets.
Impact on capital flows
Karina highlighted that the U.S. interest rates influence global capital flows, affecting African economies.
"When the Fed raises rates, higher borrowing costs in the U.S. can lead investors to withdraw capital from African markets seeking safer investments, leading to currency depreciation and higher import costs,” he explained.
This depreciation, he added, can escalate inflation, as African countries often rely on imports for essential goods, adding that conversely, lower rates can reduce inflationary pressures by making borrowing cheaper, thus stimulating economic growth.
Apart from inflation, the U.S. interest rates play a role in the dynamics of capital flows to Africa.
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According to Ogutu, Fed rate hikes, as was the case recently, have resulted to a decline in capital flows to the continent.
"With high interest rates in the U.S, as witnessed in the past four years, capital flows to Africa have been low as investors look at the appeal of the U.S. markets,” he said, adding that the private equity and venture capital space is also impacted as investors deploy less venture capital and are more selective.
While last week's Fed rate cut may not have an immediate effect on capital flows to the continent, Ogutu is optimistic that an increase could play out in the near term.
Given the impact of U.S. monetary policy decisions, experts say African policymakers should employ tools to mitigate adverse effects.
"African policy makers should consider strengthening their monetary policy frameworks by adopting more flexible and responsive monetary policies to manage inflation and exchange rates effectively,” Karina noted.
He added that improving the trade and investment climate will attract foreign direct investment and compensate for any capital flight.
For Ogutu, deepening the capital markets in African countries as well as developing and strengthening their supply chains could help reduce the volatilities that come with monetary policy changes in the U.S.