US Fed hikes rates to 0.50-75%, signals further tightening

15 December 2016

The US Federal Reserve raised interest rates on Wednesday signalling a tightening of monetary policy after years of monetary expansion. The US central bank also hinted at a faster pace of monetary tightening in the next year, in tune with the incoming Trump administration's spending plans.

The rate hike comes despite a slower-than-expected inflation rate although the labour market has strengthened. The Fed, however, said its decision has been based on realised and expected increases in inflation rate and a strengthening of the labour market conditions.

Accordingly, the Federal Open Markets Committee (FOMC) decided to raise the target range for the federal funds rate to 0.50 to 0.75 per cent.

The Fed also anticipates three rate hikes in 2017 instead of the two foreseen as of September, partly as a result of the changes anticipated under President-elect Donald Trump.

These projected increases in 2017 would be followed by another three increases in both 2018 and 2019 before the rate levels off at a long-run "normal" 3.0 per cent.

The fresh shift in economic forecasts is based on Trump's election promises of tax cuts and increased infrastructure spending, which shifted outlook to one of slightly faster growth, lower unemployment and inflation just under the Fed's 2 per cent target.

The FOMC said in a statement, ''The labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year. Job gains have been solid in recent months and the unemployment rate has declined. Household spending has been rising moderately but business fixed investment has remained soft.

''Inflation has increased since earlier this year but is still below the Committee's 2 per cent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports."

The committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to rise to 2 per cent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.

The committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data, FOMC stated.

The Fed committee said it would assess realised and expected economic conditions relative to its objectives of maximum employment and 2 per cent inflation as well as readings on financial and international developments before deciding on further measures.

The Fed will also continue reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over of maturing Treasury securities at auction. This policy, of keeping the committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions, it added.

Addressing the media after the policy announcement,  Fed chair Janet Yellen said while the rate hike decision has been unanimous, Donald Trump's election had put the central bank under a "cloud of uncertainty".

"All the (Federal Open Market Committee) participants recognise that there is considerable uncertainty about how economic policies may change and what effect they may have on the economy," Yellen said.

At least five of the 17 Fed policymakers appeared to have boosted their interest rate outlook since September, according to the new "dot plot" of rate projections.

However, Yellen said, "I am not going to offer the incoming president advice about how to conduct himself."

Trump, critical of Yellen during the campaign, is likely to replace her when her term ends in early 2018, but had not issued any comment about the Fed's rate decision.

Yields on shorter-dated Treasuries hit their highest levels in more than five years and US stocks fell in choppy action. The dollar rose against a basket of currencies while gold hit its lowest level in more than 10 months and oil prices declined.

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