Fed Raises Interest Rates for Second Time this Year

Stephen Stanley chief economist at Amherst Pierpont and Bob Browne Northern Trust CIO discuss the

Though rates are now roughly positive on an inflation-adjusted basis, the Fed still described its monetary policy as "accommodative", with gradual rate increases likely warranted as the economy enters a 10th straight year of growth.

The median forecast of members of the Fed's rate-setting Federal Open Market Committee (FOMC) puts the benchmark at 3.1 per cent at the end of 2019, up from the previous 2.9 per cent, which signals four hikes next year rather than three.

"In view of realized and expected labor market conditions and inflation, the Committee made a decision to raise the target range for the federal funds rate to 1-3/4 to 2 percent", read a portion of a Federal Open Market Committee statement released Wednesday afternoon. The rate is closely tied to adjustable-rate loans, such as home-equity lines of credit and credit cards.

The new interest rate guidance shows the Fed will continue to raise short-term rates after reaching a level Fed officials call neutral level, which is where rates neither stimulate nor slow the economy. The Fed expects unemployment to fall to 3.6% this year, and, said Powell, "Most people who want to find jobs are finding them".

The central bank also lifted its growth forecast to 2.8 per cent this year, up a small amount from its projection of 2.7 per cent annual growth in March.

Policymakers projected a slightly faster pace of rate increases in the coming months, with two additional hikes expected by the end of this year, compared to one previously.

Beginning in 2008 in the midst of the financial crisis, the Fed had kept its key rate unchanged at a record low near zero for seven years. With higher interest rates, this means that real interest rates will push higher. Fed Chairman Jerome Powell said at a news conference that the USA economy has strengthened considerably since the 2007-08 recession and is in "great shape". This would improve the Fed's communication, Powell said.

Since the Fed began holding quarterly news conferences in 2011, it has announced major policy moves only at the quarterly meetings, which have all been followed by a news conference by leader of the Fed. In the longer run, it maintained the forecast for 1.8% growth. The committee's forecast for the long-run sustainable growth rate of the economy held at 1.8 per cent, suggesting policy makers are skeptical of the effect of tax cuts on the economy's capacity for growth.

Yields have been climbing this year, as markets position for a relatively more aggressive Fed amid inflation concerns. Job gains have been strong, on average, in recent months, and the unemployment rate has declined.

The higher rates should be a boon for savers, while increasing borrowing costs for households and businesses throughout the economy. That compares with March's forecasts for 3.8 per cent this year and 3.6 per cent in the following two years.

Economists said the Fed left little doubt that it's prepared to increase the pace of its credit tightening to guard against high inflation later on.

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