US Fed hikes rate by 25 bps for first time since June 2006

The American central bank is expected to move gradually on subsequent rate hikes after this initial lift-off

The Federal Reserve on Wednesday raised interest rates by 25 basis points, the first increase in nearly a decade, in a move signalling faith that the US economy had largely overcome the wounds of the 2007-2009 financial crisis.

The US central bank's policy-setting committee raised the range of its benchmark interest rate by a quarter of a percentage point to between 0.25 per cent and 0.50 per cent, ending a lengthy debate about whether the American economy was strong enough to withstand higher borrowing costs.

"The Committee judges that there has been considerable improvement in labour market conditions this year, and it is reasonably confident that inflation will rise over the medium term to its 2 per cent objective," the Federal Reserve said in its policy statement, which was adopted unanimously.

The Fed made it clear that the rate increase was a tentative beginning to a "gradual" tightening cycle, and that in deciding its next move it would put a premium on monitoring inflation, which remains mired below target.

"In light of the current shortfall of inflation from 2 per cent, the Committee will carefully monitor actual and expected progress towards its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate," the Fed said.

New economic projections from Fed policymakers were largely unchanged from September, with unemployment anticipated to fall to 4.7% next year and economic growth at 2.4 per cent.

The statement and its promise of a gradual path represent a compromise between those who have been ready to raise rates for months and those who feel the economy is still at risk.

The median projected target interest rate for 2016 remained 1.375 per cent, implying four quarter-point rate hikes next year.

To edge that rate from its current near-zero level to between 0.25 per cent and 0.50 per cent, the Fed said it would set the interest it paid banks on excess reserves at 0.50 per cent, and said it would offer up to $2 trillion in reverse repurchase agreements, an aggressive figure that shows its resolve to pull rates higher.

Financial markets had expected the rate hike, bolstered by recent US data showing job growth continuing at a strong pace.

A Dec 9 Reuters poll had shown the likelihood of a raise on Wednesday was 90 per cent, with economists forecasting the federal funds rate to be 1.0 per cent to 1.25 per cent by the end of 2016, and 2.25 per cent by the end of 2017.

The rate hike sets off an immediate test of new financial tools designed by the New York Fed for just this occasion, as well as a likely reshuffling of global capital as the reality of rising US rates sets in.

The impact on business and household borrowing costs is unclear. One of the issues policymakers will watch closely in coming days is how long-term mortgage rates, consumer loans and other forms of credit react to a rate increase meant not to slow an economic recovery but nurse monetary policy back to a more normal footing.

The Fed emphasised it would move gingerly into its tightening cycle. That was enough to produce a unanimous vote on the policy-setting Federal Open Market Committee, as even members who had argued publicly for delaying a rate hike delay went along with Fed Chair Janet Yellen and other policymakers.

Treasuries fall

US Treasuries fell after the Federal Reserve's move to raise the interest rate by 25 basis points.The Treasury 10-year note yield rose four basis points to 2.30 per cent at 12:37 am (IST), according to Bloomberg Bond Trader prices. Two-year note yields rose by four basis points to 1.0005 per cent, rising above one per cent for the first time since 2010.

Treasuries have earned an annualised 2.5 per cent since December 2008, Bank of America Merrill Lynch indices show. With Fed policy dimming the appeal of debt, investors sought out stocks: The Standard & Poor’s 500 index generated average annual returns of about 15 per cent in that period, including reinvested dividends. 

Emerging-market stocks rise

Following the Fed move, emerging-market stocks rose the most this month.The MSCI Emerging Markets Index rose 1.5 per cent to 791.02 at 12:53 am (IST). That was about the same level it traded at before the Fed’s announcement. A Bloomberg gauge tracking 20 currencies ended a two-day gain, falling 0.3 per cent as Brazil’s real and the South African rand each weakened at least 0.9 per cent against the dollar.

The US stock indices, meanwhile, rose following the rate-hike decision. At 1:07 am (IST), the Dow Jones Industrial Average was at 17,608.42, higher by 0.48 per cent over its previous close. The Nasdaq Composite was 0.56 per cent higher at 5,023.12 and S&P 500 was 0.65 per cent higher at 2,056.73.