Published: Sat, June 17, 2017
Markets | By Erika Turner

US Fed raises rate, plans to trim portfolio

US Fed raises rate, plans to trim portfolio

The US Federal Reserve last night raised interest rates by a further 25 basis points, its second hike of the year, but given the slowing economic data, investors are split on whether a third increase will be seen this year.

"In view of realised and expected labour market conditions and inflation, the FOMC (Federal Open Market Committee) chose to raise the target range for the federal funds rate to 1 to 1.25 per cent", the American central bank said in a statement after concluding its two-day monetary policy meeting.

The third rate hike since December indicates that the central bank believes the USA economy is on solid ground. The Fed has a 2.4trn portfolio of Treasury bonds and mortgage-backed securities, and majority were in the wake of the financial calamities and slump. But some were surprised by accompanying detail indicating the Fed meant to press ahead with further rate rises in 2017 and begin reducing its $4.5trn QE balance as early as this year. The plan would involve halting reinvestments of the growing amounts of maturing securities.

The central bank also confirmed that it will begin later this year to implement a plan to reduce the size of its investment holdings, which were built up to record levels during the financial crisis to help support the economy, especially once interest rates reached zero. She suggested that balance sheet normalization could be put into effect "relatively soon". Once started, the Fed expects to sell $10 billion per month of Treasuries and mortgage backed securities, rising to $50 billion per month after 15 months.

The National Financial Supervisory Committee recently forecast the Fed rate hikes, but small increases each time would not insert significant pressure on exchange rates. Most Asian markets closed lower, but the benchmark Shanghai Composite bucked the trend to gain 0.1%. The benchmark lending rate was lifted by a quarter percentage point to a target range of 1 per cent to 1.25 per cent.

They lowered projections for 2017 to 1.6% from their March estimate of 1.9%. Inflation was expected to be at 1.7 percent by the end of this year, down from the 1.9 per cent previously forecast.

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A retreat in inflation over the past 2 months has caused jitters that the shortfall, if sustained, could alter the pace of future rate hikes.

"We continue to feel that with a strong labor market and with a labor market that's continuing to strengthen, the conditions are in place for inflation to move up", Fed Chair Janet Yellen said in a press conference following the decision.

According to the Commerce Department, retail sales fell 0.3 percent in May, which was the first decline since February and biggest drop in 16 months since January 2016.

That said, no one expects the Fed's rate hikes to turn aggressive.

The pound surged when the BOE vote tally revealed "that 3 of the 8 MPC members voted for a hike", he said.

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