Fed Raises Interest Rates As Expected

First increase in nearly a decade was largely expected.

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Reviewed by: Howard Schneider
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Edited by: Howard Schneider

Washington (Reuters) – The Fed made clear that the rate hike was a tentative beginning to a "gradual" tightening cycle, and that in deciding its next move, it would put a premium on monitoring inflation, which remains mired below target.

"In light of the current shortfall of inflation from 2%, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate," the Fed said.

Economic Projections Unchanged

New economic projections from Fed policymakers were largely unchanged from September, with unemployment anticipated to fall to 4.7% next year and economic growth at 2.4%.

The statement and its promise of a gradual path represents a compromise between those who have been ready to raise rates for months and those who feel the economy is still at risk.

"The Fed is going out of its way to assure markets that, by embarking on a ‘gradual’ path, this will not be your traditional interest rate cycle," said Mohamed El-Erian, chief economic advisor at Allianz.

The dollar firmed modestly after the rate rise. Based on interest rate futures markets, traders expect a second hike in April.

Four Quarter-Point Hikes Projected

The median projected target interest rate for 2016 remained at 1.375%, implying four quarter-point rate hikes next year.

To edge that rate from its current near-zero level to between 0.25% and 0.50%, the Fed said it would set the interest it pays banks on excess reserves at 0.50%, and that it would offer up to $2 trillion in reverse repurchase agreements, an aggressive figure that shows its resolve to pull rates higher.

Financial markets had expected the rate hike, bolstered by recent U.S. data showing job growth continuing at a strong pace.

A Dec. 9 Reuters poll showed the likelihood of a hike on Wednesday was 90%, with economists forecasting the federal funds rate to be 1.0% to 1.25% by the end of 2016, and 2.25% by the end of 2017.

The rate hike sets off an immediate test of new financial tools designed by the New York Fed for just this occasion, as well as a likely reshuffling of global capital as the reality of rising U.S. rates sets in.

Impact On Mortgages, Businesses Unclear

The impact on business and household borrowing costs is unclear. One of the issues policymakers will watch closely in coming days is how long-term mortgage rates, consumer loans and other forms of credit react to a rate hike meant not to slow an economic recovery but to nurse monetary policy back to a more normal footing.

The Fed emphasized it would move gingerly into its tightening cycle. That was enough to produce a unanimous vote on the policy-setting Federal Open Market Committee, as even members who had argued publicly for delaying a rate hike delay went along with Fed Chair Janet Yellen and other policymakers.