Fed lifts rates and projects four rises for 2018

The Federal Reserve lifted interest rates by a quarter point and signalled that two more increases are likely in 2018 as policymakers gave a bullish assessment of the US economy amid accelerating growth and rapid job creation.

The Federal Open Market Committee raised the target range for the federal funds rate to 1.75 to 2 per cent, in the seventh increase of the current cycle and the second this year. Interest-rate forecasts released by Fed policymakers pointed to a total of four rate rises in 2018, followed by another three in 2019.

In a statement, the central bank dropped previous crisis-era assurances that it will keep rates below their longer-run norms.

Increases

“The committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee’s symmetric 2 per cent objective over the medium term,” the Fed said, adding that risks to the outlook are roughly balanced.

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The US stock market dipped 0.2 per cent on the news that Fed officials planned to increase interest rates another two times this year – on top of the two that came in March and on Wednesday – while the 10-year Treasury yield jumped 3 basis points to 2.97 per cent. The dollar climbed 0.4 per cent against the euro to trade at $1.174 (€1).

The Fed’s statement suggested the central bank is getting increasingly confident about inflation, as policymakers dropped earlier statements that they are carefully monitoring price readings.

The Republicans' $1.5 trillion tax cutting package and $300 billion federal spending increase are fuelling a further pick-up on the US economy, overshadowing global hazards including the risk of a Trump-induced trade war with nations including China. As a result Jay Powell, the Fed's chairman, has vowed to continue with the programme of gradual rate rises that the Fed kicked off in late 2015.

Officials also ditched previous guidance that said that rates will for some time remain below levels “expected to prevail in the longer run”, in a sign they think policy is heading closer to neutral. However the FOMC retained its earlier assessment that policy is “accommodative” – meaning rates are still low enough to support growth.

Markets

Wednesday’s rate rise was widely predicted by financial markets given the recent fall in unemployment to just 3.8 per cent and signs that inflation is moving closer to the Fed’s 2 per cent target. In their latest forecasts on Wednesday Fed policymakers projected core inflation will rise to a median 2.1 per cent next year, slightly above the Fed’s target, and stay there in 2020.

“Inflation is still subdued, but there remains the risk that the Fed could end up behind the curve and having to tighten more quickly if inflation accelerates more sharply,” said Kully Samra, vice-president at Charles Schwab. “Markets have already been bumpy this year, and additional rate hikes could add to the volatility in the stock market.”

The question remains how high the Fed will ultimately lift rates as it balances rapid hiring against a history of disappointing wage and inflation readings. Lael Brainard, a Fed governor, is among the officials who have suggested that the central bank will need to lift rates to neutral – the level it thinks is consistent with keeping the economy on an even keel – before lifting them somewhat further.

The Fed forecasts put the midpoint of the Fed’s target range at 3.4 per cent in 2020, higher than the median prediction for the rate in the longer-run, which stood unchanged at 2.9 per cent.

Its latest median projection showed the Fed now expects the jobless rate to fall to 3.5 per cent next year, compared with the previous 3.6 per cent estimate, and hang there in 2020. That would be well below the Fed’s 4.5 per cent estimate of the longer-run rate of unemployment.

The rates decision on Wednesday saw a tweak to the way the US central bank steers interest rates. While officials raised their fed funds target rate range to between 1.75 per cent and 2 per cent, one of the rates they use to control that range was lifted by just 20 basis points, rather than the customary 25 basis-point boost. This is to ensure rates stay in the range the Fed is aiming for.

– Copyright The Financial Times Limited 2018