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US rates rise again

16/06/2017

In a move that expressed the US central bank’s growing confidence in the economy, the Federal Reserve (Fed) raised its key interest rate by 0.25% to a range of 1% to 1.25%. This was the Fed’s third increase in six months, having already tightened rates in December 2016 and March 2017 and the decision was widely expected. One member of the Federal Open Market Committee (FOMC) voted against the rate rise, compared with eight voting in favour.

The decision took the federal funds rate to its highest level since 2008 when the financial crisis took hold. Back in 2008, the Fed cut its key rate to near-zero levels and embarked on a programme of asset purchases. To date, the Fed has amassed a large portfolio of Treasury bonds and mortgage-backed securities; however, the central bank now intends to start reducing its balance sheet, although its portfolio is likely to remain larger than its pre-crisis level.

The Fed’s programme of asset purchases was implemented in a bid to keep US interest rates low and thus encourage business to borrow and invest. In a reversal of that strategy, the Fed’s latest move is designed to provide support for interest rates and bring them back to a point that will start to put a brake on demand for loans.

Although there is no definite timetable yet, the Fed is likely to begin this programme of “normalisation” this year, as long as economic growth remains intact. The central bank plans to cut its holdings by a total of US$10 billion per month for three months, after which it will raise the rate of the reductions until they reach US$50 billion per month.

Fed Chair Janet Yellen attributed the FOMC’s decision to “the progress the economy has made and is expected to make”. The US labour market has continued to strengthen and Fed officials appear to have shrugged off a dip in consumer price inflation: the rate of core consumer price inflation eased to 1.7% in May. The Fed cut its forecast for inflation this year from 1.9% to 1.6%, but still expects CPI to hit its 2% target next year. In the meantime, the FOMC intends to monitor inflation developments “closely” and, looking ahead, the Fed anticipates the “ongoing strength of the economy (to) warrant gradual increases in the Federal Funds rate”.
 

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