Ten things you should know about interest rates as Trump’s threats of a currency war loom

Say one thing for Donald Trump. He does stir things up. He has chosen this week to stir up currency markets, and he has chosen the start of the summer holidays to do so. For Britons on holiday abroad, or about to head off and whose funds are in battered sterling, this may help a bit. Or will it?

The president has done two things. On Thursday he attacked the Federal Reserve for increasing interest rates. In an interview on CNBC, he said he was “not thrilled” about higher rates, because every time the economy strengthens “they want to raise rates again”. He did add that he wouldn’t interfere with whatever The Fed decided to do. “I’m letting them do what they feel is best,” he said.

Then on Friday, he switched the attack to other countries seeking to depreciate their currencies against the dollar. “China, the European Union and others have been manipulating their currencies and interest rates lower, while the US is raising rates while the dollars gets stronger and stronger with each passing day,” he tweeted.

What should we make of all this? Here are ten things.

One, there is nothing new about politicians wanting to set or at least influence interest rates. The UK chancellor of the exchequer fixed rates until Gordon Brown ceded that power to the Bank of England in 1997. That power was common practice in other countries too, though not in the US. The mood has shifted since the 1970s and 1980s and it is now generally accepted that central banks should be independent to set interest rates as they see fit.

Two, it is natural for politicians to want lower interest rates, even though there are more savers than borrowers. For some reason lower rates are more popular, simple as that. In the case of Trump, a property developer, his political instinct allies with his experience: developers want cheap money.

Three, attitudes towards exchange rates are more mixed. Over-simplifying a bit, large businesses usually want a competitive currency so that they can sell more stuff abroad, but individuals want a strong currency so that they experience cheaper prices when they go on holiday.

Four, exchange rates can fluctuate widely under a floating exchange rate system, which most of the world operates on, though with some governments having a heavy hand in influencing them. But global commerce has generally learnt to cope and the period of floating rates since the early 1970s has seen the greatest growth in international trade that has ever occurred.

Five, in the long-run rates tend to converge on a mean, in that they reflect the different cost bases of the various economies as far as traded good are concerned. A country with rising costs, almost certainly as a result of high inflation, will see its currency depreciate to maintain its competitiveness. But because of short-term factors, currencies can diverge for quite a long time.

Six, in the short-term the most important factors determining any currency’s exchange rate are interest rates. Higher interest rates attract short-term funds, hot money, seeking to benefit from those rates. Right now the fact that US rates have been heading up, whereas those in Europe and Japan remain on the floor, has pushed money into the dollar.

Seven, the US is getting higher rates because the economy is much closer to full capacity than other developed countries, and this is starting to show through in higher inflation. Consumer prices in June were up 2.9 per cent on June last year, the highest since 2012.

Eight, other currencies have been held down by country or region-specific factors. Thus the Chinese yuan is the lowest it has been for a year because of a number of concerns about the economy, including fears of the impact of a trade war. Sterling is held down by concerns about Brexit. And the euro is held down by worries about US trade tariffs and by fears about Italian political stability.

Nine, it follows that one reason why the dollar is strong is Trump’s own policies, in particular the threat of a trade war.

And finally, ten, there is one thing to be certain about with exchange rates, and it is this: they are the hardest economic variable to predict successfully. Short-term interest rates are not easy, and longer-term ones harder still. The oil and gold prices are really difficult too. Share prices? Well if we could manage that, then we journalists would not be writing about them; we would be too rich to bother. But predicting exchange rates? That is hopeless.

So, will Donald Trump’s tweets have any lasting impact in pushing the dollar down? The short answer is no. But maybe his trade war has pushed it up.