US Fed hikes rates

After concluding a two-day meeting of its rate-setting Federal Open Market Committee (FOMC), the US Federal Reserve announced on Wednesday it would increase its benchmark interest rate to a target range of 0.5 percent to 0.75 percent, up from the current 0.25 percent to 0.5 percent.

The first rate hike in a year, and only the second in more than a decade, the 0.25-percent increase was "a vote of confidence" in the US economy, said Fed Chair Janet Yellen.

Improving economy

Since the summer, increasingly rosy economy data on the health of the world's largest economy has helped sway reluctant policymakers towards raising rates. They have overcome worries that an increase could interrupt a fledgling recovery amid directionless inflation and slack labor markets.

At the beginning of this year, the Fed's plans for what it described as a "normalization" of interest rates fell off track due to poor US growth and hiring at the end of 2015, and combined with fears of economic turbulence in China. Moreover, Britain's shock vote to exit the European Union in June dissuaded the Fed from raising rates later in 2016.

Policymakers also provided clues as to their monetary policy in the coming year, in which the administration of President-elect Donald Trump settles into office. Trump has said he wants a major tax cut and infrastructure spending program, even as the economy approaches full employment and wages are rising.

This raises the specter of accelerating inflation in 2017, said Northern Trust chief economist Carl Tannenbaum. "Inflation risks are more significant than they were three months ago. Rates could well rise more than anticipated," he told the news agency Reuters

Policy outlook

The Fed's median outlook for rates rose to three quarter-point increases in 2017 from two as of September. That would be followed by another three increases in both 2018 and 2019 before the rate levels off at a long-run "normal" three percent.

This was a sign that the Fed feels the economy is still gaining traction, said Aaron Kohli, interest rate strategist at BMO Capital. "They didn't mention the fiscal stimulus but typically their aggressiveness does indicate that there's a little more confidence that they can get away with three hikes next year."

But Trump's economic policy could call for an even faster course of rate increases, said Michael Scanlon, managing director of Manulife Asset Management. "I think the market is pricing in about two hikes for 2017, but if the Trump administration is able to reduce corporate taxes, I wouldn't be surprised to see four hikes next year," he told Reuters.

On Wednesday, a report by the US Labor Department said the index for final demand producer prices grew 0.4 percent for November, surpassing an analyst forecast which foresaw an increase of only 0.1 percent. The result pointed to an overall upward trend since sluggish summer months. Year-on-year, the index even posted its largest gain since November 2014, suggesting higher consumer prices in the months ahead.

For the time being though, the strength of the US currency counteracted inflationary pressure, thus complicating plans for US monetary policy, said Joel Naroff of Naroff Economic Advisors. "The strong dollar is keeping inflation down, which is a challenge for the Fed. But how long the dollar's rally will continue is unclear," he said in a note.

uhe/jd (Reuters, dpa, AFP)