For the third time in six months, the U.S. Federal Reserve has raised its benchmark interest rate – this time, by a quarter-point. The announcement, widely predicted by economists, is the latest vote of confidence in the U.S. economy. It’s also an indication that Federal Reserve Chairperson, Janet Yellen, is seeking to normalize rates from the rock bottom lows they’ve sat around since the financial crisis in 2008.
Starting now, short-term rates in the U.S. will range from 1 to 1.25 per cent. The Fed also announced it plans to gradually start paring its $4.5 trillion investment in treasury and mortgage bond holdings by $6 billion a month, meaning long-term rates will start to rise too.
The increase does mean higher borrowings costs for consumers and businesses, but better returns for Americans with money in the bank.
The rate hike comes despite the fact that 2017 (in the U.S.) is off to a sluggish start. The Fed predicts this is temporary and expects the economy to pick up steam for the remainder of the year. They’re also buoyed by the ultra-low unemployment rates at 4.3 per cent. That’s even lower than what the central bank associates with full employment. Improved household spending and business investment is also helping to create a more favourable environment for higher rates. The Fed is now forecasting one more rate hike before the end of the year.
In a statement released right after the announcement, the Fed discloses, “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
This incoming data includes inflation as it currently remains below the Fed’s target of 2 per cent. Raising rates will also make this target harder to reach.
Furthermore, uncertainty in Washington remains a key concern for the central bank. It’s still unclear as to how President Donald Trump and his administration will tackle key issues like health care, tax cuts and national borrowing limits throughout the rest of President Trump’s term. Current investigations into his administration also raises some questions.
For all these reasons, it’s likely the Fed will not be aggressive in raising rates and will remain cautious.
Rate trends in Canada
Like the U.S., interest rates in Canada have been near history lows for several years. The difference is the Bank of Canada has been reluctant to raise rates in the last several announcements. Generally speaking, Canada likes to be in step with the U.S. but this has not been the case over the last 18 months.
The next U.S. Federal Reserve rate announcement is July 26, 2017.
The next Bank of Canada rate announcement comes in advance of the Fed’s, on July 12, 2017.