Fed raises interest rate by 0.25% and indicates more to come

The US Federal Reserve board has pushed up interest rates for only the second time in a decade, and signalled a faster pace of expected rate increases next year.

The Fed, the US central bank, increased interest rates by 0.25 of a percentage point on Wednesday, following on from a similar increase a year ago.

However, market attention focused on the signals from the Fed that the governors who sit on its policymaking committee are now expecting three interest rate increases next year, compared to two previously.

With signs of stronger growth in the US economy, which may be boosted by tax cuts by the incoming Trump administration, the Fed’s statement will add to market expectations that inflation and interest rates are now firmly on the rise.

Fed signals that interest rates are now firmly on the rise

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The latest increase, widely expected by the markets, moves the target for the Fed’s key short-term rate to between 0.5 and 0.75 per cent.

The Fed said in a statement that it was responding to a tightening jobs market and rising inflation. Fed chair Janet Yellen played down the changed outlook for interest rates in 2017. "This is a very modest adjustment in the path of the federal funds rate," she said during a press conference after the announcement.

Significant

However, market analysts saw the move as significant, and Ms Yellen said that some participants in the Fed meeting, but not all, had incorporated expected changes in tax and spending polices in their forecasts. These “may have been a factor” in the changed outlook.

She added that “changes in fiscal policy or other economic policies could potentially affect the economic outlook”, but said “ “it is far too early to know how these policies will unfold”.

The Dow Jones Industrial Average rose as much at 0.3 per cent to a new record high after the announcement – within 34 points of the 20,000-point level – before falling back.

The Fed increased interest rates a year ago, and the latest rise had been well flagged to the financial markets.

Reaction across the markets was mixed on Wednesday, with the most pronounced effect seen in currencies. The dollar rose to $1.056 against the euro from $1.064 immediately before the announcement, as investors looked beyond the increase to focus on the prospect of three further rate increases next year.

“With the Fed predicting that the US economy will continue creating jobs at its current prodigious rate and the rate hike escalator underpinned by an expectation of rising inflation, dollar confidence is riding high in the countdown to the start of the Trump presidency,” said David Lamb, head of dealing with Fexco’s corporate payments division.

Surprised

Denis Debusschere, a global portfolio strategist at Evercore ISI in New York, said the market had been somewhat surprised by the outlook for rate increases for next year as it had been expecting the Federal Reserve to wait for details of US president-elect Donal Trump’s budget plans before taking such a bold move.

“The consensus going in was that they’d wait until they had the details of the fiscal programme before they actually raised the rate forecast, and they did that before they saw the details.” .

The market interest rate, or yield, on US 10-year bonds rose by 0.04 percentage points to 2.51 per cent.

The Fed was responding in large part to recent economic data. Even before any fiscal expansion by the Republicans, recent figures suggest the Fed is already closing in on its employment and inflation goals.

Steady hiring has driven the unemployment rate to just 4.6 per cent as of November – below Fed policymakers’ median estimate of its long-run rate.

And inflation as measured by the personal consumption expenditures price index excluding food and fuel is at 1.7 per cent, not far from the Fed’s 2 per cent target. – Additional reporting, Copyright The Financial Times Limited 2016)