For the first time this year and for the second time in almost a decade, the U.S. Federal Reserve is raising its key interest rate. The central bank announced it is increasing its benchmark rate by 25 bases points, to a still-low range of 0.5 percent to 0.75 percent. The last time the Fed raised rates was in December 2015 from a record low near zero, set during the 2008 financial crisis.
In a statement made after the announcement, the Fed also mentioned that additional rate increases are likely as the economy improves and inflation edges closer to its ideal two per cent target.
This move ultimately shows that the Fed has confidence in the U.S. economy. In addition, the incoming government’s plan for tax cuts and infrastructure spending are also leading investors to expect inflation to pick up in the coming months.
Before Donald Trump’s victory this past November, economists were in consensus that the Fed would raise rates twice in 2017. Now, some are saying there could be as many as four interest rate hikes.
However, Federal Reserve Chair Janet Yellen is downplaying expectations that a Trump presidency could lead to faster rate hikes.
Yellen attributed the increase to the 4.6 per cent unemployment rate as well as some incoming changes to the federal budget policy beginning next year, although she emphasized that any changes to the projections were “modest.”
Some investors agree
Brian Jacobsen, chief portfolio strategist at Wells Fargo Asset Management said in reaction to the hike, “Overall, I don’t think the Fed’s move and shift in projections are a game changer for the markets.” Jacobsen adds, “Monetary policy is still accommodative and we could be simply living through a long and protracted period where interest rates gradually rise.”
He notes, the central bank is walking a delicate balance: Higher interest rates means that borrowing will be more expensive, which can slow corporate profits and economic growth. But one of the worst-case scenarios for the economy would be if inflation rose higher because the Federal Reserve was too slow to raise rates.
The U.S. Economy has started to pick up after growing at a slow annual rate of 1.1 percent in the first half of this year. In the third quarter, it accelerated to 3.2 percent. This is fostering hope that the economy will keep rising, fuelled by steady hiring gains.
The rate increase by the Fed is in stark contrast to the Bank of Canada’s announcement last week to leave rates unchanged. Canada’s central bank noted economic conditions and inflation targets were still not right for a rate hike.
The Fed rate hike is putting more downward pressure on our Canadian dollar. Immediately after the announcement, bond yields were higher, and as expected, the U.S dollar became stronger.
A lower Canadian dollar will drive up the cost of imported items. Consumer should expect higher prices on all items that are imported from the U.S., from cars to groceries.
However, it should be a positive for the manufacturing industry and make our exports more attractive.