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The Federal Reserve raised its benchmark interest rate by a quarter-point last Wednesday, sending a message of confidence in the US economy despite evidence of weaker price increases in recent months.

The increase, which will bring the Fed funds rate to between 1pc and 1.25pc, was highly anticipated by the markets. Last Wednesday morning before the rate increase, Fed futures pointed to a 93.5pc chance of a rate hike.

“The rate hike signals that the Fed believes the economy is improving and is going to be resilient to those hikes,” said Tara Sinclair, a professor at George Washington University and a senior fellow at the jobs website Indeed.

The increase was the second rate hike this year and the third within six months. As such, consumers will begin to feel the impact of more expensive lending rates — especially those with large mortgages or those who carry credit-card debt, said Greg McBride, chief financial analyst at Bankrate.

“For a lot of people, they don’t even notice,” he said. “But for those where budgets are tight and their debt burdens have been growing the last few years, this is where the signs of strain begin to emerge.”

The Fed described the rate hike as evidence of a stronger economy. It said that job gains had ‘moderated’ but were still ‘solid, on average, since the beginning of the year.’ As it has in previous months, it said its interest rate remains ‘accommodative,’ meaning that it is still low enough to help fuel economic activity.

The Fed said that it expects to begin implementing this year a policy to roll back the massive balance sheet it accumulated in an effort to prop up the economy after the financial crisis.

“The rate hike signals that the Fed believes the economy is improving and is going to be resilient to those hikes”

The US job market has been growing robustly, and the unemployment rate reached a 16-year low in May. Yet metrics of inflation, including the Fed’s favoured measure, have consistently come in below the Fed’s target, convincing some that the Fed should put off future interest rate hikes.

In its news release last Wednesday, the Fed said it expected inflation to remain somewhat below its 2pc target in the near term but to eventually rise to meet that goal. It added that it was ‘monitoring inflation developments closely.’

In a speech in January, Fed Chair Janet Yellen argued that a gradual path of rate increases was the best way to avoid a more damaging scenario for the economy. If the Fed failed to raise interest rates gradually now, it might have to hike rates more quickly later in the event of rising inflation, and that could destabilise the economy, she said.

Board members didn’t alter their projections for the economy much compared with what they had expected in March. The median projections showed that they expected the Fed’s funds rate to reach 1.4pc by the year’s end, translating into one more rate increase this year after the June hike.

Economic projections also released by the central bank indicate that the Fed now expects the economy to grow 2.2pc in 2017 and 2.1pc in 2018. Board members did lower their estimates for the unemployment rate and inflation, metrics that have consistently fallen below their expectations.

The Fed’s decision was nearly unanimous. Eight members of the Fed’s deciding Federal Open Market Committee voted in favour of the rate increase. Only one, Neel Kashkari, the president of the Minneapolis Federal Reserve, voted against it.

The Fed gave more details of its plan to gradually roll back its balance sheet, a change that many analysts expect could lead longer-term interest rates to rise.

For Treasury securities, the Fed said it will begin reinvesting only those that exceed a cap of $6 billion a month, initially. Then it will lift the cap by $6bn every three months over a period of a year, until the cap reaches a level of $30bn per months.

The plan for agency debt and mortgage-backed securities follows the same concept but with different amounts. The Fed said it will reinvest only those securities that exceed a cap of $4bn per month initially, increasing the cap in steps of $4bn every three months over the period of a year until it reaches $20bn per month.

After that, the Fed plans to hold the caps in place ‘until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.’ Eventually, it said, the amount will decline to a level below that seen in recent years, but more than before the financial crisis.

Madhavi Bokil, a vice president at Moody’s Investor Services, said her group was closely monitoring information about how the Fed will roll down its balance sheet, to analyse what the effect might be on credit conditions. “We think that if the same gradual approach is followed, then any potential negative spillover would be limited,” she said.

The Washington Post Service

Published in Dawn, The Business and Finance Weekly, June 19th, 2017