Most of the world’s largest central banks are either turning or remain hawkish. Last week the Federal Reserve raised its rate for the first time since 2023. The Bank of Japan lifted its rate to its highest level since 1995. The Bank of England held its rate. The European Central Bank raised its rate the week before.
The Fed raised rates due to rising inflation. Its committee voted unanimously to raise the rate by a quarter point, to a range of 3.75% to 4%. Prices have remained high due to a combination of tariffs, the energy shock from the Iran war, and heavy spending on AI. This trend showed no improvement over the summer. Sixteen of eighteen officials expect another hike this year. The Fed now expects inflation to reach its 2% target only in 2029. The bond market adjusted ahead of the interest rate decision. On September 15th the US 10-year Treasury yield touched 5.04%, its highest level since July 2007. One reason was oil trading above $100 a barrel. Investors also want more return for holding US debt as the deficit grows and tech firms borrow heavily to build data centres. The 10-year yield decides the price of American mortgages. The average 30-year mortgage rate has climbed to 6.95%.
Japan raised rates owing to the pickup in the oil and wage bills. The country imports almost all of its oil, so higher crude prices pass directly into living costs. The central bank of Japan also pointed to steady wage growth and a shrinking workforce. The rise to 1.25% came three months after the last one, half the previous gap. The yen fell after the decision because investors sought a clearer roadmap for rake hikes. Japan’s 10-year yield reached 3% last week for the first time since 1996.
The Bank of England held rates. Its committee voted 6 to 3 to keep the rate at 3.75%, with three members voting for 4%. UK inflation rose to 3.1% in August, and the Bank expects it to go higher. The majority held because there is little sign yet that costly energy is feeding into wages and wider prices. Markets consider the hold as a pause. British borrowing costs have also reached a level last seen just before the global financial crisis. On Thursday the 10-year gilt yield rose 10 basis points to 5.378%, its highest since July 2007.
Investors welcomed the rate decisions, but rising energy prices soon unsettled markets again. In New York the S&P 500 rose after the Fed’s announcement. The gain faded once Saudi Aramco told European refineries to expect no crude next month and US diesel prices hit a record. In London the FTSE 100 closed 1.2% higher on the day the Bank of England held, even as gilt yields climbed. In Tokyo the Nikkei gained after the Bank of Japan’s hike.
Households in all three countries remain unsettled and expect prices to keep rising. In the US, the University of Michigan’s sentiment index fell to 47.8 in September, its second-lowest reading on record. Americans expect prices to rise 4.6% over the next year, and prices have outpaced average wages for five straight months. In Britain, the Bank of England’s survey found the public expects inflation of 4% over the next year and 3.9% in five years’ time, both well above the 2% target. In Japan, consumer confidence recovered to 35.5 in August but remains far below the 50 mark that signals optimism. Core inflation there has stayed under 2% for seven months, which partially explains the stance taken by board members who opposed the recent hike.
What does this mean for Sri Lanka?
Sri Lanka faces the same external pressures. Inflation reached 8.0% in August, a three-year high. It was above the Central Bank’s upper limit for the second month in a row. The current account has been in deficit for four months, mainly because fuel imports cost more. Brent was at $106 in mid-September. Crude eased late last week after Saudi Arabia moved to restore shipments through its damaged pipeline, but prices are still high. Gloomy households in Britain and the US may also spend less on foreign travel, which would weigh on already faltering tourism earnings. Strong remittances flows may however counteract this current account drag. The Central Bank last policy decision was a hike by 100 basis points to 8.75% in May with the next rate decision to be made at the end of this month.
Rising bond yields in the US, Britain and Japan make it harder for smaller markets to attract money. Higher Japanese rates also make it less attractive to borrow cheaply in yen and invest abroad, a flow that has long supported emerging markets. The effect is already visible in the region. India’s 10-year yield rose to near a four-month high, partly because of higher global yields.