The Federal Reserve on Wednesday raised its key short-term interest rate — the federal funds rate — for the first time since 2006, ending the near zero rates that have been in place since 2008. However interest rates may remain low compared with the pre 2008 recession times, for many years.

 

The policy making Federal Open Market Committee (FOMC) said in its traditional statement:

The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2% objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2%. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2% inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2% inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2%, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

Andrew Haldane, chief economist at the Bank of England and a member of the Bank’s Monetary Policy Committee, said last summer that the financial markets suggest that in Japan and the Euro Area, official interest rates are only expected to have reached 1.2% and 2.0% respectively ten years hence.

And in the UK and US, they are only expected to have reached 2.5% and 3.4% respectively by 2025.

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The rise was the first in the funds rate since June 29, 2006, when it was last hiked by 25 basis points to 5.25%. The decision was unanimous.

The Financial Times reports that the two-year Treasury yield rose to more than 1% for the first time since 2010 and the dollar slipped slightly versus the euro after the decision. The S&P 500 stock market index extended its gain to 1.5 per cent for the day, bringing it back into positive territory for the year.

Janet Yellan, Fed chair, said at a press conference:

This action marks the end of an extraordinary seven-year period. It also recognises the considerable progress that has been made toward restoring jobs, raising incomes and easing the economic hardship of millions of Americans.

Median interest-rate projections from the Fed's economists suggested rates could rise by another 100 basis points (1%) in 2016, a faster pace than predicted by financial markets. Their median estimate for the longer-term federal funds rate stayed unchanged at 3.5%.

The main jobless rate is at 5% while the labour participation rate is down from 66% in December 2007 to a 1977-year low of 62.5% in November 2015 — 1977 was a time when there was rising participation by women in the workforce.

Steve Blitz of ITG Investment Research commented:

The deed is done and the Fed has delivered to us all a wonderful holiday gift — something new to write and talk about: When is the next hike?....Reading from the minutes and the dot plots, the Fed’s plan is for the funds rate to rise to the inflation rate by year-end 2016 and then modestly pull ahead by year end 2017 and then move to a 1.5% real rate by year end 2018. Ah, the sweet world of econometric model outcomes. All of this is, of course, contingent on core inflation rising in 2016 towards their target and, first and foremost, that progress continues for the labor market.

The Federal Reserve has raised interest rates for the first time in nine years, but the future path of rates and the central bank's tools for controlling them remain uncertain, say Gillian Tett, John Authers and Cardiff Garcia.

 

The long awaited rise in US interest rates was met with a mixture of relief and concern in Asia. Frédéric Neumann from HSBC says that short-term certainty over US monetary policy is good for markets but that the longer-term worry for the region is the Chinese economy.

 

Pic above: The Marriner S. Eccles Federal Reserve Board Building, Washington DC.