Fed raises key rate and unveils plan to reduce bond holdings
WASHINGTON — The Federal Reserve has raised its key interest rate for the third time in six months, providing its latest vote of confidence in a slow-growing but durable economy. The Fed also announced plans to start gradually paring its bond holdings later this year, which could cause long-term rates to rise.
The increase in the short-term rate by a quarter-point to a still-low range of 1 percent to 1.25 percent could lead to higher borrowing costs for consumers and businesses and slightly better returns for savers. The Fed foresees one additional rate hike this year, unchanged from its previous forecast. It gave no hint of when that might occur.
The Fed chose to raise rates again despite economic weakness at the start of 2017 and a further slowdown recently in inflation, which remains persistently below the Fed’s 2 percent target rate. Fed officials reiterated their belief that that both inflation and economic growth will pick up.
The Fed’s decision was approved on an 8-1 vote with Neel Kashkari, head of the Fed’s Minneapolis regional bank, dissenting in favor of holding rates unchanged.
The latest rate increase, announced in a statement after a Fed policy meeting, comes as the U.S. economy is growing only sluggishly. Even so, many of the barometers the Fed monitors most closely have given it the confidence to keep gradually lifting still-low borrowing rates toward their historic norms.
In particular, hiring in the United States remains solid if slowing, with employment at a 16-year-low of 4.3 percent — even below the level that the Fed associates with full employment.
The Fed’s announcement that it would begin paring its balance sheet later this year — “provided that the economy evolves broadly as anticipated” — involves its enormous portfolio of Treasury and mortgage bonds. The Fed began buying the bonds after the Great Recession to try to depress long-term loan rates. That effort resulted in a five-fold increase in its portfolio to $4.5 trillion.
On Wednesday, the Fed said it would eventually allow a small amount of bonds to mature without being replaced — an amount that would gradually rise as markets adjusted to the process. This process could put upward pressure on long-term borrowing rates.
Under the plan it unveiled, the Fed would start with monthly reductions in Treasury holdings of no more than $6 billion and $4 billion in mortgage bonds. Those figures would rise in increments over a year until they reached $30 billion a month in Treasurys and $20 billion in mortgage bonds.
By using a gradual pace for reducing its bond holdings, the Fed hopes to avoid upsetting financial markets..
The Fed on Wednesday also issued updated economic forecasts that showed it still foresees one additional rate increase this year, to following Wednesday’s increase and an earlier rate hike in March.
The rate forecast, based on the individual projections for each member, envisions three more rate hikes in 2018 and three more in 2019. By then, the Fed’s forecast would put its key policy rate at 3 percent. That’s the level the Fed believes is a neutral rate — neither stimulating economic growth nor restraining it.
But the Fed’s forecasts are only predictions and are frequently revised as its assessments evolve.
The revised economic forecast bowed to reality by reducing its estimate for unemployment by year’s end to 4.3 percent from a March projection of 4.5 percent. Unemployment has already reached a 16-year low of 4.3 percent.