Fed raises interest rates as it points to stronger US growth

The Federal Reserve lifted short-term interest rates by a quarter-point and forecast that rates will rise higher than previously expected in the coming years as its new chairman Jay Powell responds to strengthening growth at home and abroad.

The US central bank raised the target range for the federal funds rate by a quarter point to 1.5-1.75 per cent as it predicted inflation will accelerate in the coming months. The Fed’s median forecast for interest rates at the end of 2018 was left unchanged, but its projections pointed to an extra increase in 2019.

“The economic outlook has strengthened in recent months,” the Fed said in a statement following its latest two-day meeting. “The committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labour market conditions will remain strong.”

Shortly after he took over the Fed in February Mr Powell signalled the US had hit an important turning point, as previous drags, including fiscal policy, reversed direction and provided a lift to growth. Republican tax cuts and a deal on Capitol Hill to boost limits on spending are set to deliver a major short-term stimulus; the $1.5 trillion tax cuts should on their own add half a percentage point to growth this year and next, according to Fed governor Lael Brainard.

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Median forecast

Wednesday’s increase in the Fed’s target rate was widely expected by the financial markets. While some traders expected the Fed to pencil in a total of four rate rises this year, the median forecast in Fed officials’ rate outlook remained unchanged at three.

In its statement the Fed said the economy had been expanding at a “moderate” rate and noted a slowdown in household and business investment. Early estimates of growth in the first quarter of 2018 point to a deceleration to 1.8 per cent from the 2.5 per cent annualised pace reported for the final quarter of 2017.

However, economists expect the slowdown to be a fleeting one, due to buoyant business and consumer confidence and widespread growth overseas. The Fed’s forecasts for 2018 projected an annualised expansion of 2.7 per cent, compared with 2.5 per cent in its December outlook, and 2.4 per cent next year compared with 2.1 per cent previously.

The Fed’s deliberations have been clouded by stubbornly sub-target inflation, but top officials including Mr Powell have suggested they are getting more confident about the outlook for price growth. The Fed’s statement reflected that optimism, predicting that the 12-month rate of price growth would “move up in the coming months” before stabilising at target in the medium term.

According to the Fed’s forecasts, core inflation will rise to 2.1 per cent next year, slightly above the Fed’s target, and hover there in 2020.

The Fed said job gains have been “strong” in recent months. The US jobless rate held at 4.1 per cent in February, equal to its lowest since the tech boom, while payroll employment expanded by a robust 313,000.

Its latest median projection showed the Fed now expects the jobless rate to fall to 3.6 per cent next year, below the previous 3.9 per cent estimate, and stay there in 2020. That would be well below the Fed’s 4.5 per cent estimate of the longer-run rate of unemployment.

There were no dissents to the decision to lift interest rates. – Copyright The Financial Times Limited 2018