Federal Reserve raises interest rates as attention turns to 2018

Chair Janet Yellen says that she and her colleagues expect a 'modest lift' to economic growth from the tax cuts being proposed by President Donald Trump

Federal Reserve Chair Janet Yellen is due to step down in February (Carolyn Kaster/AP)

The Federal Reserve has raised interest rates by a quarter of a percentage point, but has left its rate outlook for the coming years unchanged even as policymakers project 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.

US stocks extended their gains after the release of the policy statement, while Treasury yields dropped to session lows.

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.

Federal Reserve Chair Janet Yellen said that she and her colleagues expect a “modest lift” to economic growth from the tax cuts being proposed by President Donald Trump and Republican legislators.

Ms Yellen said at a news conference that the likelihood of lower taxes is why Fed officials expect the economy to grow at 2.5 per cent in 2018. But growth would then slip back closer to its recent 2 per cent average.

She said the potential for greater consumer spending and capital investments from tax cuts have been reflected in part by rising stock prices.

Ms Yellen cautioned, however, that there is “considerable uncertainty” about the impact of the tax cuts, which are estimated to add at least $1 trillion to the national debt over the next decade. She noted that any wage growth would likely stem from the low unemployment rate, rather than the tax cuts.

Policymakers do see the federal funds rate rising to 3.1 percent in 2020, slightly above the 2.8 percent “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 $12 billion and $8 billion, respectively. That is consistent with its balance sheet reduction plan.

Reuters