Fed hikes rates, warns more coming as it brushes off Trump jabs

The US Federal Reserve building in Washington, DC. The Fed kept the benchmark interest rate unchanged after increasing in March. (File pic: Karen Bleier, AFP)

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Federal Reserve officials raised interest rates for a third time this year and reaffirmed their outlook for further gradual hikes well into 2019, risking fresh criticism from President Donald Trump.

The quarter-point increase boosted the benchmark federal funds rate to a target range of 2% to 2.25%. The move reflected an upbeat assessment of the economy that was identical to the central bank’s last policy statement eight weeks ago, despite concerns over Trump’s escalating trade war.

Growth and job gains have been “strong” and inflation remains near the central bank’s 2% target, the Federal Open Market Committee said in its statement on Wednesday following a two-day meeting in Washington. Barring a negative surprise in the economy, updated “dot plot” forecasts made a December rate hike almost certain, as the number of FOMC officials expecting another increase by year-end grew to a bigger majority of 12, from eight in the previous round of projections in June.

In the statement’s only change from the previous one issued August 1, the committee dropped its long-standing description of monetary policy as “accommodative”. That’s an acknowledgment rates have moved closer to the neutral level which neither boosts nor restrains the economy.

Fed Chairperson Jerome Powell and his colleagues are trying to pull off a feat the central bank has accomplished only once in its 104-year history: Engineer a soft landing of the economy by raising rates just enough to prevent overheating, but not so much that they trigger a recession.

Eighth hike

After eight hikes since late 2015, the fed funds rate is now at the highest level since October 2008, just after the collapse of Lehman Brothers.

Voters on the committee backed the decision 9-0.

Trump isn’t making the Fed’s tricky task any easier. Aside from criticising recent rate hikes, he’s launched a trade war with China that threatens both to slow growth and boost inflation. Tariffs on an additional $200bn of imported goods from China took effect on Monday, along with retaliatory levies from Beijing.

Fed officials remained sceptical that Trump’s tax cuts will result in a persistent boost to economic growth. While they raised projections for expansion this year and next, they predicted that growth would slow to 1.8% by 2021. That’s in line with their estimate for the economy’s long-run potential and contrasts with the Trump administration’s goal of sustained 3% growth.

In their post-meeting statement and updated economic projections, Fed policy makers made no mention of trade worries and showed no sign they would soon halt the upward march of rates.

“The committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions and inflation near the committee’s symmetric 2% objective,” the statement said, repeating previous language.

Year ahead

The committee, enlarged to 16 by the recent addition of new Fed Vice Chairperson Richard Clarida, continued to anticipate three hikes in 2019, according to the median estimate.

Investors have questioned whether the Fed will ultimately prove so aggressive, preferring to price in two increases next year. If the central bank’s outlook prevails, traders will eventually be forced to adjust their rate-hike expectations and lift long-term rates.

It was the first time since this round of rate increases began in late 2015 that the Fed hasn’t described policy as “accommodative”. Any signal in that change, however, is unclear.

The location of a neutral rate for policy is the subject of heated debate, with estimates within the committee ranging from 2.5% to 3.5%. Powell has repeatedly played down the importance of neutral given economists’ inability to know precisely where it lies.

Moreover, policy makers haven’t agreed on what they should do when rates reach neutral. Some favour a pause while others argue they should push rates above neutral before stopping.

Balanced risks

Fed officials, in the statement, repeated their assessment that “risks to the economic outlook appear roughly balanced”.

The median forecast in the most recent set of projections continued to show officials expect borrowing costs to move above their estimate for the long-run neutral rate, reaching 3.4% in 2020, the same as in the June forecasts.

The new projections also included the first numbers for 2021, when officials see rates remaining steady at 3.4%. The median long-run neutral estimate moved up slightly to 3% from 2.9%.

The Fed’s hike widens a gap with its peers elsewhere. The European Central Bank said it will maintain its policy rate of minus 0.4% at least through next summer, while the Bank of Japan is set to stick with its current settings until 2020.

Higher US rates, though, may force more emerging markets to tighten monetary policy to defend their currencies at a time when investors are punishing those with fault lines such as large current-account deficits.

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