U.S. ex­pe­ri­ences new-found strength, ris­ing in­fla­tion pow­ered by spend­ing

Fed ex­pects ac­cel­er­a­tion in fu­ture hikes as it raises key rate amid hot econ­omy

Ottawa Citizen - - FP - MARTIN CRUTSINGER

The Fed­eral Re­serve has raised its bench­mark in­ter­est rate for the sec­ond time this year and sig­nalled that it may step up its pace of rate in­creases be­cause of solid eco­nomic growth and ris­ing in­fla­tion.

The Fed now fore­sees four rate hikes this year, up from the three it had pre­vi­ously fore­cast.

The cen­tral bank on Wed­nes­day raised its key short-term rate by a mod­est quar­ter-point to a still-low range of 1.75 per cent to two per cent. The move re­flects the econ­omy’s re­silience, the job mar­ket’s strength and in­fla­tion that’s fi­nally near­ing the Fed’s tar­get level.

The ac­tion means con­sumers and busi­nesses will face higher loan rates over time.

It was the Fed’s sev­enth rate in­crease since it be­gan tight­en­ing credit in 2015, and it fol­lowed an in­crease in March this year.

When the Fed last met in May, it left its short-term rate un­changed. But it noted that in­fla­tion was edg­ing near its two-per-cent tar­get af­ter years of re­main­ing un­de­sir­ably low. Should in­fla­tion even­tu­ally pick up, the Fed might move to tighten credit more ag­gres­sively.

A grad­ual rise in in­fla­tion is co­in­cid­ing with new-found eco­nomic strength. Af­ter years in which the econ­omy ex­panded at roughly a tepid two per cent an­nu­ally, growth could top three per cent this year. Con­sumer and busi­ness spend­ing is pow­er­ing the econ­omy, in part a re­sult of the tax cut U.S. Pres­i­dent Don­ald Trump pushed through Congress late last year.

With em­ploy­ers hir­ing at a solid pace month af­ter month, un­em­ploy­ment has reached 3.8 per cent. Not since 1969 has the job­less rate been lower.

Be­gin­ning in 2008 in the midst of the fi­nan­cial cri­sis, the Fed kept its key rate un­changed at a record low near zero for seven years. It then raised rates once in 2015, once in 2016, three times in 2017 and now twice this year.

The Fed aims to achieve its man­dates of max­i­miz­ing em­ploy­ment and sta­bi­liz­ing prices by low­er­ing rates to spur growth dur­ing times of eco­nomic weak­ness and rais­ing rates to slow growth if the econ­omy threat­ens to over­heat. When the Fed tight­ens credit, it aims to do so with­out de­rail­ing the econ­omy. But if it mis­cal­cu­lates and over­does the credit tight­en­ing, it can trig­ger a re­ces­sion.

The eco­nomic ex­pan­sion has sur­vived for nine years and is now the sec­ond-long­est in his­tory. It will be­come the long­est if it lasts past June 2019, at which point it would sur­pass the ex­pan­sion that lasted from March 1991 to March 2001.

While many econ­o­mists think the cur­rent ex­pan­sion will ex­ceed the 1990s streak, some worry about what might oc­cur once the im­pact of the tax cuts be­gin to fade and the Fed’s grad­ual rate hikes be­gin to curb growth.

Diane Swonk, chief econ­o­mist at Grant Thorn­ton, has sug­gested that the econ­omy could ex­pe­ri­ence a “growth re­ces­sion,” in which the gross do­mes­tic prod­uct slows so much that un­em­ploy­ment starts to rise.

The Fed’s pace of rate hikes for the rest of the year could end up re­flect­ing a tug of war be­tween a sturdy econ­omy and the risks to growth, in­clud­ing from a po­ten­tial trade war that could break out be­tween the United States and such key trad­ing part­ners as China, the Euro­pean Union, Canada and Mex­ico. All those coun­tries have vowed to re­tal­i­ate against any U.S. tar­iffs with their own penal­ties against U.S. goods.

A global trade war would risk cut­ting into U.S. eco­nomic growth by de­press­ing Amer­i­can ex­port sales and rais­ing in­fla­tion by mak­ing con­sumers and busi­nesses pay more for imports.

The Fed’s meet­ing this week is to be fol­lowed by pol­icy meet­ings of two other ma­jor cen­tral banks — the Euro­pean Cen­tral Bank on Thurs­day and the Bank of Ja­pan on Fri­day.

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