Friday 15 December 2017

Fed raises interest rate again and predicts more hikes as US economy improves

Federal Reserve Chair Janet Yellen speaks during a news conference in Washington, as the Fed raised its benchmark interest rate again (AP)
Federal Reserve Chair Janet Yellen speaks during a news conference in Washington, as the Fed raised its benchmark interest rate again (AP)

The Federal Reserve has raised its benchmark interest rate for the second time in three months and forecast two additional hikes this year.

The move reflects a consistently solid US economy and will likely mean higher rates on some consumer and business loans.

The Fed's key short-term rate is rising by a quarter-point to a still-low range of 0.75% to 1%.

The central bank said in a statement that a strengthening job market and rising prices had moved it closer to its targets for employment and inflation.

The message the Fed sent on Wednesday is that nearly eight years after the Great Recession ended, the economy no longer needs the support of ultra-low borrowing rates and is healthy enough to withstand steadily tighter credit.

The decision, issued after the Fed's latest policy meeting, was approved 9-1.

Neel Kashkari, president of the Fed's regional bank in Minneapolis, was the dissenting vote.

The statement said Mr Kashkari preferred to leave rates unchanged.

The Fed's forecast for future hikes, drawn from the views of 17 officials, still projects that it will raise rates three times this year, unchanged from the previous forecast in December.

However, the number of Fed officials who think three rate hikes will be appropriate for 2017 rose from six to nine.

The central bank's outlook for the economy changed little, with officials expecting growth of 2.1% this year and next year before slipping to 1.9% in 2019.

Those forecasts are far below the 4% growth that President Donald Trump has said he can produce with his economic programme.

The Fed's rate hike should have little effect on mortgages or auto and student loans.

The central bank does not directly affect those rates, at least not in the short run.

However, rates on some other loans - notably credit cards, home equity loans and adjustable-rate mortgages - will likely rise soon, though only modestly.

Those rates are based on benchmarks like banks' prime rate, which moves in tandem with the Fed's key rate.

After the Fed's announcement, major banks began announcing that they were raising their prime lending rate from 3.75% to 4%.

Mark Vitner, an economist at Wells Fargo, noted that the Fed's statement provided little hint of the timing of the next rate hike.

The lack of specificity gives the Fed flexibility in case forthcoming elections in Europe or other unseen events disrupt the global economy.

"They don't want to prematurely set the table for a rate hike," Mr Vitner said.

"I think they're confident, but it's hard not to be cautious after we've had so many shocks over the years."

Stock prices rose and bond yields fell as traders reacted to the Fed's plans to raise rates gradually.

The Dow Jones industrial average, which had been only modestly positive before the decision was announced, closed up 112 points.

The Fed's statement made few changes from the last one issued on February 1.

However, it did note that inflation, after lagging at worrisomely low levels for years, has picked up and was moving near the Fed's 2% target.

And it adopted some new language hinting that it might be tolerant of higher-than-optimal inflation for some unspecified period.

Economists said this suggested that officials could let inflation top their 2% target, just as inflation remained stuck below 2% for years after the Great Recession.

The new language "reflects the fact that inflation may run above 2% for some time", Michael Gapen, an economist at Barclays, said in a note to clients.

Many economists think the next hike will occur no earlier than June, given that the Fed probably wants time to assess the likelihood that Congress will pass Mr Trump's ambitious programme of tax cuts, deregulation and increased spending on infrastructure.

In recent weeks, investors had seemed unfazed by the possibility that the Fed would raise rates several times in the coming months.

Instead, Wall Street has been sustaining a stock market rally on the belief that the economy will remain durable and corporate profits strong.

A robust February jobs report - 235,000 added jobs, solid pay gains and a dip in the unemployment rate to 4.7% - added to the perception that the economy is fundamentally sound.

That the Fed is no longer unsettling investors with the signal of forthcoming rate increases marks a sharp change from the anxiety that prevailed after 2008, when the central bank cut its key rate to a record low and kept it there for seven years.

During those years, any slight shift in sentiment about when the Fed might begin raising rates - a step that would lead eventually to higher loan rates for consumers and businesses - was enough to move global markets.

The Fed has managed its control of interest rates with exceeding caution, beginning with an initial hike in December 2015.

It then waited an entire year before raising rates again in December last year.

But now, the economy is widely considered sturdy enough to handle modestly higher loan rates.

While the broadest gauge of the economy's health - the gross domestic product - remains below levels associated with a healthy economy, many analysts say they are optimistic that Mr Trump's economic plans will accelerate growth.

His proposals have managed to boost the confidence of business executives and offset concerns that investors might otherwise have about the effects of Fed rate increases.

Yet for the same reason, some caution that if Mr Trump's programme fails to survive Congress intact, concerns will arise that his plans will not deliver much economic punch.

Investors may start to fret about how steadily higher Fed rates will raise the cost of borrowing and slow spending by consumers and businesses.

AP

Press Association

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