Published: Thu, June 14, 2018
Markets | By Erika Turner

Fed Raises Interest Rates for Second Time this Year

Fed Raises Interest Rates for Second Time this Year

"Recent data suggest that growth of household spending has picked up, while business fixed investment has continued to grow strongly", the Fed wrote in its statement on Wednesday announcing the interest rate hike.

Interest rate hikes will hit consumers in their wallets. "This is the most lopsided, mismatched labour market in the nation's history", said Chris Rupkey, chief financial economist at MUFG Union Bank.

The Fed statement released after its two-day meeting said the economy "has been rising at a solid rate", compared with its assessment in May when policymakers described the economy as advancing moderately. This raises some speculation that every meeting becomes live for a possible adjustment to rates as it offers the chance for the Fed to explain its move in an open forum.

Officials now expect four rate rises this year, not three as the balance of policymakers has shifted since March. The Fed had said its key rate "is likely to remain, for some time, below levels that are expected to prevail in the longer run".

To be sure, the Fed is not inclined to hike rates any more than gradually after years of mostly over-optimistic predictions for inflation and economic growth, and disappointing wage gains of around 2.5 percent annually.

Projections released after the Fed's two-day meeting in Washington show policymakers expect the USA economy will grow 2.8% this year, while unemployment falls to 3.6%. That means that by then, it thinks its key rate will finally exceed the 2.9 percent it sees as neutral - as neither stimulating nor restraining growth.

In its updated forecasts, the Fed envisions stronger growth this year, with the economy expanding 2.8 percent, up from the 2.7 percent it predicted in March.

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The Fed anticipates that inflation will overshoot its 2% target this year; in March, officials saw that happening only in 2020.

The median dot plot showed a projected Fed Funds track 25bps higher than previously for 2018 and 2019, but that simply reflected an upgrading of view of just one member.

Fast-forward to April of this year when data showed that USA job openings jumped to a record high, far outpacing hiring. The index rose 1.8 per cent in April from a year earlier. Consumer and business spending is powering the economy, in part a result of the tax cut President Donald Trump pushed through Congress late a year ago. Unemployment is 3.8%, the lowest since 2000, and inflation is creeping higher.

The reflection of increased fears about rising prices is likely to surprise markets, as most economists had not expected the Fed to give a clear sign that an additional rate increase was likely until later in the year. It then raised rates once in 2015, once in 2016, three times in 2017 and now twice this year.

Ten years ago, the Fed cut interest rates to near zero in an effort to boost the economy and stem the deepening financial crisis and recession. Prices did not spike in response to the huge monetary stimulus, nor has the job market cooled since 2015 when the Fed began tightening policy.

The decision reflected an economy that's getting even stronger.

Trump's imposition of tariffs on steel and aluminum imports has enraged US allies. It would allow the Fed to be less choreographed and more flexible in cutting or raising rates as economic conditions warrant.

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