U.S. Federal Reserve on Wednesday decided to raise benchmark interest rate by 25 basis points, the first interest rate increase since 2006 and marking the end of an era of extraordinary easing monetary policy.
"Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the (Federal Open Market) Committee decided to raise the target range for the federal funds rate to 0.25-0.5 percent," the Fed said in a statement after concluding its two-day policy meeting on Wednesday.
The central bank holds that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise to its 2 percent target over the medium run. "This action marks the end of an extraordinary seven-year 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," the Fed chairwoman Janet Yellen said at a press conference on Wednesday.
CONFIDENCE IN ECONOMIC OUTLOOK
With gradual adjustments in the stance of monetary policy, the U.S. economy will continue to expand at a moderate pace and labor market will continue to strengthen, said the central bank in the statement.
Fed officials also see the risks to outlook for both economic activity and the labor market as balanced. "Although developments abroad still pose risks to U.S. economic growth, these risks appear to have lessened since last summer," said Yellen.
According to a projection report released on Wednesday, Fed officials expected the U.S. economy will grow 2.4 percent in 2016, slightly higher than their September forecast of 2.3 percent. The unemployment rate will further fall to 4.7 percent in 2016, lower than their September forecast of 4.8 percent.
"The U.S. economy has exhibited enough strength over the past year, and the unemployment rate has fallen far enough that raising rates by 25 basis points will not derail the U.S. expansion," David Stockton, a former Fed economist and now senior fellow at the Peterson Institute for International Economics (PIIE), told Xinhua.
In regard to concern of raising interest rate in a persistently low inflation environment, Yellen explained that transitory factors that are holding down the inflation, such as low oil prices and a strong U.S. dollar, are expected to abate over time, and diminishing slack in labor and product markets should put upward pressure on inflation as well.
As it takes time for monetary policy actions to affect future economic outcomes, it is appropriate for the Fed to take action now in order to avoid overheating the economy and overshooting the inflation target, according to Yellen.
GRADUAL RATE HIKES AHEAD
In light of the current shortfall of inflation from the central bank's 2 percent target, the Fed expects that the developments of economic conditions will warrant "only gradual" increases in the benchmark interest rate, according to the statement.
The core personal consumption expenditure price index, the Fed's favored inflation gauge, increased only 1.3 percent year on year in October. The future increases in interest rate will be data dependent and the central bank will not follow any mechanical formula in the path of rate hikes, said Yellen.
According to the projection report, Fed officials expected the federal funds rate to reach 1.4 percent in 2016, 2.4 percent in 2017, and 3.3 percent in 2018, compared with their September forecast of 1.4 percent in 2016, 2.6 percent in 2017, and 3.4 percent in 2018. This implies that the central bank will likely increase interest rate by 25 basis points for four times next year, but the pace for rate hikes in 2017 and 2018 will be slower than their September forecasts.
"With inflation remaining so low, the Fed will need to be cautious about further removal of monetary accommodation," said Stockton. He said that the Fed should not be on any fixed path of a series of rate hike, but must be attentive to the incoming data on inflation and must monitor the effects of their actions on the strength of economic activity.
FED DOWNPLAYS IMPACT ON EMERGING ECONOMIES
At the press conference, Yellen downplayed the negative spillover impact on emerging market economies. Although there can be negative spillovers through capital flows, there are also positive spillovers on to the emerging market economies, as the rate hike takes place in the context of a strong U.S. economy, said Yellen.
According to the central bank chief, many emerging markets are in the stronger position than they would have been in the 1990s. Emerging market economies have stronger macroeconomic policies, and have taken steps to strengthen their financial systems, said Yellen.
"I do not see Fed policy as posing significant risks to the Chinese economy at this point," Stockton told Xinhua. Fed tightening could add fuel to capital outflows from China, but the country has sufficient reserves to offset the effects of the capital outflows, said Stockton.
Nicholas Lardy, a senior fellow at the PIIE, also held the similar view. He said "the impact of Fed's move on Chinese economy is quite modest." According to Lardy, capital outflow is only a moderate issue to China, as the reduction in the official holding of U.S. dollar-denominated assets might reflect the fact that Chinese corporates are repaying their dollar-denominated loans back to commercial banks. "Dollars (assets) are now in commercial banks rather than in the central bank, and the money has not gone out of China," said Lardy.
According to the expert, China has a great deal of autonomy in managing its macro-policies, and the performance of the Chinese economy depends to very considerably extend on what happened to the housing market. If housing investment continues to slow down in 2016, China's economic growth will slow further to 6.5 percent next year. On the other hand, if the housing market was on the verge of recovery, as some people believed, the economy will probably grow around 7 percent, according to Lardy.
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