7 yrs after meltdown, Janet makes rate hike gamble

The US Federal Reserve has raised the interest rates by one quarter percentage, the first in seven years when America tumbled into a deep financial crisis with the collapse of the Wall Street.

“The Federal Open Market Committee decided to raise the target range for the federal funds rate by one quarter percentage point bringing it to one quarter to one-half per cent,” US Federal Reserve Board Chairwoman Janet Yellen told reporters at a briefing on Wednesday.

This action marks the end of an extraordinary seven-year long period during which the Federal Reserve funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression, she said. It also recognises the considerable progress that has been made toward restoring jobs, raising incomes and easing the economic hardship of millions of Americans, Yellen said.

The decision reflects the committee’s confidence that the economy will continue to strengthen, she said, adding that the economic recovery has clearly come a long way, although it is not yet complete.

“Room for further improvement in the labor market remains and inflation continues to run below our longer run objective. But with the economy performing well and expected to continue to do so, the committee judged that a modest increase in the federal funds rate target is now appropriate. Recognising that even after this increase, monetary policy remains accommodative,” Yellen said. According to Yellen, the process of normalising the interest rates is likely to proceed gradually, although future policy actions will obviously depend on how the economy evolves relative to their objectives of maximum employment and two percent inflation. “Since March, the committee has stated that it would raise the target range for the federal funds rate when it had seen further improvement in the labor market and was reasonably confident that inflation would move back to its 2 per cent objective over the medium term,” she noted.

Yellen said the Federal Reserve currently expects that with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen, although developments abroad still pose risks to US economic growth. These risks appear to have lessened since last summer, she observed. 

Following the announcement Rahul Shah, Vice President Equity Advisory Group, Motilal Oswal Securities said the rate hike going forward will be gradual and data driven. “After seven years of the most accommodative monetary policy in US history, the Fed, as widely expected, approved a quarter-point increase in its target funds rate. Rate hike as expected, in line with street estimate, and in short comment of Yellen, that Rate hike going forward will be gradual and data driven,” Shah said. Yellen told reporters that the median projection for real GDP growth is 2.1 per cent for this year and rises to 2.4 per cent in 2016. 

“Thereafter, the median growth projection declines toward its longer run rate. The median projection for the unemployment rate in the fourth quarter of this year stands at 5 per cent, close to the median estimate of the longer run normal unemployment rate,” she said.

Fed also approved a .25 percentage point increase in the discount rate for primary credit, to one per cent. “Based on the extensive testing of our policy tools in recent years, the committee is confident that the normalisation process will proceed smoothly,” she said. Responding to questions, Yellen cautioned against overblowing the significance of this first move.

“It’s only 25 basis points. If monetary policy remains accommodative, we’ve indicated that we will be watching what happens very carefully in the economy in terms of our actual, and forecast, our projected conditions relative to our employment and inflation goals,” she said. Acknowledging that the Fed has been concerned about the risks from the global economy, she said the US economy has shown considerable strength. “Domestic spending that accounts for 85 per cent of aggregate spending in the US economy has continued to hold up. It’s grown at a solid pace,” she said. “While there is a drag from net exports, from relatively weak growth abroad and the appreciation of the dollar, overall, we decided today that the risks to the outlook for the labor market and the economy are balanced,” Yellen said.

“We recognise that monetary policy operates with lags. We would like to be able to move in a prudent and, as we’ve emphasised, gradual manner. It’s been a long time since the Federal Reserve has raised interest rates, and I think it’s prudent to be able to watch what the impact is on financial conditions and spending in the economy,” Yellen added.