Federal Reserve

US Fed increases interest rate by 25 bp as era of cheap money ends

The central bank’s statement suggests that three further rises should be expected in 2017; Yellen says US economy ‘remarkably resilient’

PUBLISHED : Thursday, 15 December, 2016, 3:09am
UPDATED : Thursday, 15 December, 2016, 5:34am

The US Federal Reserve raised benchmark interest rates for the first time in 12 months, ending an era of cheap money as the world’s largest economy heads into the new year led by a president-elect whose policies are likely to have far-reaching effects.

In a widely anticipated and much-delayed move, the US central bank’s policy-setting committee announced that the benchmark interest rate would rise by 25 basis points, boosting federal fund rates to a target range of between 0.5 and 0.75 per cent, up from 0.25 to 0.5 per cent since December 2015.

“This is a very modest adjustment in the path of the federal funds rate,” Fed Chair Janet Yellen told reporters in a briefing after the decision on interest rates was released.

The move “should certainly be understood as a reflection of the confidence we have in the progress that the economy has made and our judgment that that progress will continue,” Yellen said. “And the economy has proven to be remarkably resilient, so it is a vote of confidence in the economy.”

The Fed’s new projections have the unemployment rate dipping to 4.5 per cent by the end of 2017 and remaining at that level in 2018. It foresees economic growth reaching 1.9 per cent this year and 2.1 per cent in 2017. That’s slightly more optimistic than the Fed projected in September.

The central bank kept its long-term estimate for economic growth at 1.8 per cent, far below the 4 per cent pace that Trump has said he can achieve with his economic programme.

As many as three rate increases are likely in 2017, the Fed said. That compares with market anticipation of between two to five further moves in the next year.

“A December increase was almost certain, following the unexpected decision in September” to delay raising the rate, said Andrew Sullivan, managing director for sales trading at Haitong International Securities in Hong Kong. “Inflation expectations in the US are rising due to the economic policies” proposed by US president-elect Donald Trump, he said.

“When Trump said that he expected and would like to see higher interest rates, the markets didn’t respond, which suggests that they’re ready,” he said.

The Hong Kong Monetary Authority will be compelled to follow the US Fed action in raising the cost of funds in the city because of the Hong Kong dollar’s peg to the US currency.

Hong Kong’s banks are expected to announce changes in their loan and deposit rates in the course of the business day.

While the impact of the widely telegraphed rate rise is of little significance, a faster pace of future increases will cause problems particularly for property developers, manufacturers and exporters, because Hong Kong’s economic cycle is less prepared for the move, while banks and insurers will benefit, analysts said.

“At this stage, changing the forecasts radically up or down would probably be interpreted politically as validating (up), or rejecting (down) Trump’s policy platform, for which details are still scarce and implementation uncertain,” Standard Chartered analysts led by Thomas Costerg wrote in a note before the announcement.

“The status quo could be a relatively safe option,” they wrote.

The dollar rallied, while Treasury yields spiked as the Federal Reserve signalled a steeper path for interest rates going forward after their first hike in borrowing costs in 2016. US stocks slumped the most since October.

The greenback climbed to its strongest level in 10 months versus the yen, advancing against most of its major peers as traders speculated that US rates may be elevated faster than previously thought. Utilities and energy shares drove the S&P 500 Index down 0.8 per cent as two-year Treasury yields soared to their highest level in seven years. The dollar’s gains sent oil tumbling as crop futures and gold also retreated. Emerging-market currencies were among the biggest decliners as shares in developing nations slumped.