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Federal Reserve meets on historic rate rise

Wednesday, December 16, 2015 - 06:57

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The Federal Reserve began a two-day meeting on Tuesday to weigh a landmark interest rate increase that will signal the end of more than seven years of crisis-era, easy-money monetary policy.

[WASHINGTON] The Federal Reserve began a two-day meeting on Tuesday to weigh a landmark interest rate increase that will signal the end of more than seven years of crisis-era, easy-money monetary policy.

With the US economy growing steadily at a modest pace, the Fed is expected to conclude that it is time to get away from the ultra-low interest rates that have underpinned the recovery from the 2008-2009 Great Recession.

Some economists inside and outside the US central bank believe the economy is still not ready for tighter money, and that there is still no compelling reason to hike, like the threat of inflation.

But most analysts believe the Fed will nevertheless decide to embark on what will be a series of increases in the benchmark federal funds rate over the coming two years.

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Fed Chair Janet Yellen said on December 2 that the Fed expects the economy will continue to grow steadily through 2016 and that, even though inflation remains low and there is still significant slack in the jobs market, both issues would disappear next year.

Moreover, she added, if the Fed waits too long, "we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals."

The Yellen-led Federal Open Market Committee (FOMC) will announce its decision at 2.00pm (1900 GMT) Wednesday, along with Fed projections for growth, inflation and interest rates over the next two years.

Shortly after that, Yellen meets the media to explain the decision.

Most economists expect the federal funds rate will be lifted from the current 0-0.25 per cent by a quarter percentage point.

Raising it by a notch is not a big change in monetary policy, but after nearly three years preparing the ground, it is a monumental step for the FOMC.

"The Fed is not trying to slow down a fast-growing economy or dampen runaway inflation," said Sam Stovall, equity strategist at S&P Capital IQ. A hike would be "an attempt to recalibrate, not restrain."

Yet some question whether the central bank needs to act now, especially as much of the rest of the world is easing monetary policy to counter weak economic growth.

Economist Paul Krugman warned that a rate hike "could end the run of good economic news." "And this would be much more serious than a modest uptick in inflation, because it's not at all clear what the Fed could do to fix its mistake."

The Financial Times, meanwhile, said in an editorial that the Fed "will, on balance, be moving too early." "The value of waiting outweighs that of acting now."

Even so, the Fed has so strongly signaled the decision that it can hardly not raise the rate without scaring markets.

"Given the strength of the signals that have been sent it would be credibility-destroying not to carry through with the rate increase," economist and former US Treasury secretary Larry Summers wrote in a blog post on Tuesday.

Most will be watching for what Yellen and the FOMC indicate about the pace of economic growth and future rate increases.

That can determine long-term interest rates on car and home loans, financing for businesses and foreign governments, and savers' deposits.

Speculation on how fast the Fed will hike ranges from between two and four quarter-point increases next year, depending on inflation. A faster pace would more quickly tighten the economy and send the US dollar higher, and possibly dampen equity markets.

On Tuesday, after days trading in a cautious range ahead of the Fed meeting, US and European share markets erupted with buying.

The blue-chip Euro Stoxx 50 index shot up 3.26 per cent and, in New York, the S&P 500 added 1.2 per cent.

The dollar was little changed at US$1.0914 per euro, but jumped to 121.76 yen.

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