Federal Reserve

Federal Reserve raises US interest rates, predicting tax cuts will provide ‘some lift’ to economy

PUBLISHED : Thursday, 14 December, 2017, 4:45am
UPDATED : Thursday, 14 December, 2017, 7:11am

The Federal Reserve raised interest rates by a quarter of a percentage point on Wednesday, as anticipated, but left its rate outlook for the coming years unchanged even as policymakers projected a short-term acceleration in US economic growth.

The move, coming at the final policy meeting of 2017 and on the heels of a flurry of relatively bullish economic data, represented a victory for a central bank that has vowed to continue a gradual tightening of monetary policy.

Having raised its benchmark overnight lending rate three times this year, the Fed projected three more hikes in each of 2018 and 2019 before a long-run level of 2.8 per cent is reached. That is unchanged from the last round of forecasts in September.

“Economic activity has been rising at a solid rate … job gains have been solid,” the Fed’s policy-setting committee said in a statement announcing the federal funds rate had been lifted to a target range of 1.25 per cent to 1.50 per cent.

Federal Reserve Chair Janet Yellen said tax legislation making its way through Congress would likely help propel economic growth, but the extent of that boost is unclear.

“While changes in tax policy will likely provide some lift to economic activity in coming years, the magnitude and timing of the macroeconomic effects of any tax package remain uncertain,” she told reporters on Wednesday in a press conference following the Fed’s announcement of its third interest rate hike this year.

Yellen said the tax package, the passage of which is not yet certain, played into stronger economic forecasts released on Wednesday by Fed officials. House and Senate negotiators on Wednesday reached a tentative compromise for the tax overhaul.

“Participants generally identified changes in tax policy as a factor supporting this modestly stronger outlook, although many noted that much uncertainty remains about the macroeconomic effects of the specific measures that ultimately may be implemented,” Yellen said.

Republicans in US Congress forge deal on final tax legislation with voting likely next week

Fed officials acknowledged in their latest forecasts that the economy had gained steam in 2017 by raising their economic growth forecasts and lowering the expected unemployment rate for the coming years.

Gross domestic product is expected to grow 2.5 per cent in 2018, up from the 2.1 per cent forecast in September, while the unemployment rate is seen falling to 3.9 per cent next year, compared to 4.1 per cent in the last set of projections.

But inflation is projected to remain shy of the Fed’s 2 per cent goal for another year, with weakness on that front remaining enough of a concern that policymakers saw no reason to accelerate the expected pace of rate increases.

That means that the Trump administration’s tax overhaul, if passed by Congress, would take effect without the central bank having flagged any likely response in the form of higher rates or concerns of a jump in inflation.

“It shows at least some members of the Fed don’t see any reason to keep hiking rates in an environment where the economy is growing more strongly but certainly not overheating and where inflation hasn’t become a problem and doesn’t look like it is going to be one,” said Kate Warne, investment strategist at Edward Jones.

US inflation slows down as focus turns to how this will affect interest rates in 2018

Policymakers do see the federal funds rate rising to 3.1 per cent in 2020, slightly above the 2.8 per cent “neutral” rate they expect to maintain in the long run. That indicates possible concerns about a rise in inflation pressures over time.

As it stands, inflation is expected to remain below the Fed’s target in the near term and is being monitored “closely” by policymakers.

Chicago Fed President Charles Evans and Minneapolis Fed President Neel Kashkari dissented in the policy statement on Wednesday.

The Fed also said that, as of January, it would raise the amount of Treasury bonds and mortgage-backed securities that it would not reinvest on a monthly basis to US$12 billion and US$8 billion, respectively. That is consistent with its balance sheet reduction plan.

Yellen said her goal is to provide a smooth transition to her designated successor, Jerome Powell.

Yellen told reporters she is still expected to lead one more Fed meeting but that her goal is to transfer her responsibilities to Powell, a Fed governor nominated by President Donald Trump to lead the US central bank starting in February.