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US Federal Reserve raises interest rate by 0.25% for first time in almost a decade

Published 16/12/2015

The Eccles Building is the headquarters of the US Federal Reserve in Washington
The Eccles Building is the headquarters of the US Federal Reserve in Washington

The US Federal Reserve has raised its key interest rate by 0.25%, ending seven years of near-zero rates.

But it signalled that further rate hikes are likely to be made slowly as the economy strengthens further and muted inflation rises.

Governor of the Bank of England Mark Carney
Governor of the Bank of England Mark Carney

The Fed's move to lift its key rate by a quarter-point to a range of 0.25% to 0.5% ends an extraordinary seven-year period of near-zero rates that began at the depths of the 2008 financial crisis.

Consumers and businesses could now face modestly higher rates on some loans.

The Fed's action reflects its belief that the economy has finally regained enough strength six-and-a-half years after the Great Recession ended to withstand higher borrowing rates.

But the statement announcing the rate hike said the committee expects "only gradual increases" in rates going forward.

Investors' immediate reaction to the Fed's announcement, which was widely anticipated, was muted as stocks moved slightly up. Higher interest rates in the US tend to cause the dollar to strengthen against other currencies.

The bond market did not react much. The yield on the 10-year Treasury note held steady at 2.27%.

Rates on mortgages and car loans are not expected to rise much soon. The Fed's benchmark rate does not directly affect them. Long-term mortgages, for example, tend to track 10-year US Treasury yields, which are likely to stay low as long as inflation does and investors keep buying Treasurys.

But rates on some other loans, such as credit cards and home equity credit lines, are likely to rise, though probably only slightly as long as the Fed's rate hikes remain modest.

Shortly after the Fed's announcement, major banks began announcing that they were raising their prime lending rate from 3.25% to 3.50%. The prime rate is a benchmark for some types of consumer loans such as home equity loans. Wells Fargo was the first bank to announce the rate hike.

For months, chairwoman Janet Yellen and other Fed officials have said they expected any rate hikes to be small and gradual. But nervous investors have been looking for further assurances.

An updated economic forecast released with the policy statement showed that 14 of the 17 Fed officials foresee four or fewer rate hikes in 2016. That is in line with the consensus view of economists that the Fed's target for the federal funds rate - the rate that banks charge on overnight loans - will end next year at around 1%.

The Fed's action was approved by a unanimous vote of 10-0, giving Ms Yellen a victory in achieving consensus.

The Fed statement struck a generally more upbeat tone in its assessment of the economy.

It cited "considerable improvement" in the job market and expressed more confidence that inflation, which has been running well below the Fed's 2% target, would begin rising. It suggested that this would happen as the effects of declines in energy and import prices fade and the job market strengthens further.

The central bank's target for the federal funds rate - the interest that banks charge each other - has been at a record low between zero and 0.25% since December 2008. At the time, Fed officials led by Ben Bernanke were struggling to contain a devastating financial crisis that triggered the worst recession since the Great Depression.

The recession officially ended in June 2009. But unemployment kept rising, peaking at 10% before starting to fall. The jobless rate is now at a seven-year low of 5%, close to the Fed's target for full employment.

On Tuesday Mark Carney played down the prospects of the UK following the rise in the US rate, insisting the economic conditions for it were still not in place.

The governor of the Bank of England told the Financial Times that Britain still faced a "low for long" scenario.

In July, Mr Carney - who introduced a "forward guidance" policy designed to give some clues as to future movements - suggested the decision on when to begin moving away from record-low rates would "likely come into sharper relief around the turn of the year".

However with inflation remaining well below target, he suggested that scenario had not materialised.

"Were those conditions fulfilled as we proceeded through the year? No, they weren't . So in terms of overall growth, it's been there, but in terms of the cost developments, it hasn't been," Mr Carney told the newspaper.

"One can expect more active macroprudential policy, tighter macroprudential policy, all other things being equal, because it allows monetary policy to do its job," he added - hinting at stronger controls on lending.

Defending the "forward guidance" policy, he said: "Did I know that oil was going to fall 12% in the last 10 days? No, I didn't know that.

"The Chinese hadn't given me 12 months' heads up that they were going to come off the peg. I didn't realise that, either. But I will continue to try to frame as accurately as possible what's guiding my decision process."

"You don't want to know everything that's going on in my mind, I can assure you. But you do want to know the sort of key elements that are more likely to affect that decision, and that's what I'm trying to do."

Online Editors

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