Fed raises discount rate to 0.75pc
The US Federal Reserve raised the discount rate charged to banks for direct loans by a quarter point to 0.75pc and said the move will encourage financial institutions to rely more on money markets rather than the central bank for short-term liquidity needs.
“These changes are intended as a further normalization of the Federal Reserve’s lending facilities,” the central bank said today in a statement.
“The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy.”
The dollar jumped as the Fed took another step in a gradual retreat from its unprecedented actions to halt the financial crisis.
The Fed has provided hundreds of billions of dollars in backstop credit to banks, bond dealers, commercial paper borrowers and troubled financial institutions such as American International Group.
“This is an unwinding of another unusual and exigent circumstance,” said David Zervos, visiting adviser to the Fed Board in 2009 who is now a managing director at Jeffries & Co in New York.
“They tried to go out of their way to tell people this doesn’t change their policy outlook at all.”
The dollar rose to $1.3487 per euro today from $1.3607 in late New York trading on February 17. It touched $1.3444, the strongest level since May.
The discount rate increase is effective on February 19. The Board also said that effective March 18 “the typical maximum maturity for primary credit loans will be shortened to overnight.”
The Fed Board said the outlook for policy remains “about as it was at the January meeting of the Federal Open Market Committee.”
The central bank also cited last month’s statement, which said economic conditions are likely to warrant “exceptionally low” levels of the federal funds rate “for an extended period.”
It was the first increase in the discount rate in more than three years, and the move widens the rate’s spread over the top range for the benchmark federal funds rate to 0.5 percentage point.
“The Fed is moving back to doing business as normal and business as normal is not targeting an exceptionally low fed funds rate of zero to 0.25pc,” said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.
“Today they raised the discount rate, and not tomorrow or the next day, but soon, they will be lifting the fed funds rate target as well.”
Reliance on credit
Financial institutions’ reliance on Fed credit has waned as market liquidity improved. Discount window loans stood at $14.1bn on February 17, down from $65.1bn about a year earlier.
“The increase in the spread and reduction in maximum maturity will encourage depository institutions to rely on private funding markets for short-term credit and to use the Federal Reserve’s primary credit facility only as a backup source of funds,” the Fed Board said in a statement.
“The Federal Reserve will assess over time whether further increases in the spread are appropriate,” the Fed said.
Fed Chairman Ben Bernanke telegraphed the move in February 10 testimony to Congress when he said investors should expect a “modest increase” in the rate “before long.”
Using language similar to today’s statement, he said a move shouldn’t be interpreted as a change in policy.