Fed raises benchmark rate on strength of job gains
Three more increases predicted in 2017 as economic outlook improves
The U.S. Federal Reserve has hiked its benchmark interest rate for the first time in a year — and for only the second time in a decade — as U.S. job growth gathered steam.
In a statement, the Fed said job gains in recent months have been solid, while consumer spending has been rising moderately. The Fed therefore raised the upper bound of its trendsetting federal funds rate to 0.75 per cent, up from 0.5 per cent. It said it also foresees three more rate hikes in 2017.
“This is a very modest adjustment in the path of the federal funds rate,” Federal Reserve chair Janet Yellen told a press conference Wednesday.
The last time the U.S. Fed’s Open Market Committee increased its benchmark rate was December 2015. Prior to that, you’d have to go back to June 2006 to find an instance in which the Fed hiked, rather than cut or held, its federal funds rate.
“In view of realized and expected labour market conditions and inflation, the committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 per cent,” the committee said in a statement. All 10 members of the committee voted for the increase.
The Fed is forecasting that the U.S. unemployment rate will end 2017 at 4.5 per cent. That’s slightly below a previous year-end forecast of 4.6 per cent. The current rate is already at 4.6 per cent.
U.S. president-elect Donald Trump has called for fiscal stimulus through infrastructure spending and tax cuts.
On Wednesday, Yellen said the U.S. employment picture is already so strong there’s no need for the boost. “I believe my predecessor and I called for fiscal stimulus when the unemployment rate was substantially higher than it is now,” Yellen said.
The committee said the U.S. job market continues to strengthen and U.S. economic activity is expanding at a moderate pace, though it also noted that business investment has been soft. The Fed’s mandate is to foster job growth and rein in inflation. U.S. job gains are mounting, and U.S. inflation seems to be gathering steam. The Fed expects U.S. inflation to hit its target of two per cent in mid-2018.
“The move up is a signal that the Fed has become more confident in the economic outlook and that inflation will increasingly track closer to the two per cent target, motivating the committee to step up its efforts to normalize monetary policy,” said James Marple, a senior economist with TD Economics.
But in an important shift, the Fed has changed the language it uses to describe inflation. It says inflation has risen “considerably,” a noticeable shift from last November, when it described the increase in inflation as “low.”
“Of course, the wording of the statement had to change from the prior meeting in order to be consistent with hiking now rather than continuing to wait. In particular, what’s key is that they’ve now seen enough on the jobs front to be comfortable nudging rates higher,” said Avery Shenfeld, chief economist of CIBC Capital Markets. “Still, the economic backdrop in terms of growth still has cautionary notes about weakness in capital spending, while the wording on inflation reminds readers that labour compensation and price momentum are still below where the Fed wants to steer them.”
Leading into Wednesday, economists expected the U.S. Fed would continue to increase rates over time, but at a cautious pace. The median projections the Fed issued after its meeting indicated that Fed officials expect three rate hikes in 2017, up from two increases in the federal funds rate in their prior quarterly projections.
The Fed has signalled this in previous statements, and the language remained the same on Wednesday.
“The committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate,” the statement reads. “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.”
The move up is a signal that the Fed has become more confident in the economic outlook.