US Fed raises rates despite trade concerns

The US Federal Reserve raised short-term interest rates for a third time this year and signalled it would forge ahead with plans to tighten policy even as central bankers face White House pressure for low borrowing costs as well as concerns over a trade war.

The Federal Open Market Committee boosted the target range for its key rate by another quarter percentage point to 2 to 2.25 per cent, in the eighth increase of the current cycle, while teeing up a further increase in December.

The central bank dropped previous assurances that policy was “accommodative” as it removes the economic stimulus it put in place during the crisis. Median forecasts for interest rates released by the Fed’s policymakers pointed to one more rise this year, followed by three increases in 2019 and another in 2020 – in line with previous expectations.

US stocks and treasuries rallied as the Fed indicated it was on track for further rises. Wall Street indices pushed slightly higher, and the yield on the benchmark 10-year US Treasury was 2.4 basis points down at 3.0778 per cent. The dollar remained flat.

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The US central bank is on course for tighter policy as unemployment heads toward multi-decade lows, wage growth accelerates to its quickest pace in nine years, and estimates point to annualised third-quarter growth of more than 4 per cent.

Tariffs

US president Donald Trump’s decision to impose tariffs on nearly $200 billion of Chinese imports has dented confidence among some US businesses, but the Fed made no reference to trade worries in its post-meeting statement.

Instead, it gave a bullish update on the economy, which it expects to grow by more than 3 per cent this year, saying growth and job gains have been strong, as have spending and corporate investment. Risks to the outlook remain “roughly balanced,” the Fed said.

The prospect of rates reaching neutral levels – those that neither boost the economy nor hold it back – has opened up a debate over the extent to which officials want to clamp down on the economy by increasing them further.

Some Fed officials have argued that rates should be lifted even more quickly as they respond to strong financial markets, above-trend growth, steady tightening in the jobs market and inflation that has largely returned to the central bank’s 2 per cent target.

Others want to see a pause when rates are at neutral. The Fed’s decision to drop the “accommodative” language may be taken by some investors as a signal that the Fed may not need to lift rates that much further given their proximity to neutral settings.

However, some officials have pointed to surging asset values and corporate borrowing as evidence that financial stability risks are rising, adding to arguments in favour of further tightening.

The median of the latest forecasts suggest the middle of the Fed’s target range will peak at 3.4 per cent in 2020, remaining at that level in 2021. That is above the Fed’s estimate for the longer-run level of the rate, which edged up to 3 per cent.

Trade policies

The rate rises have come against a background of griping from President Trump, who has said he is “not thrilled” by the Fed’s tightening policy. Further complicating the backdrop are White House trade policies that impose 10 per cent tariffs on $200 billion of Chinese products, on top of previous levies on steel and aluminium imports.

The Fed is attempting to untangle the implications of higher tariffs for both inflation and growth. The central bank’s latest median economic forecasts, unveiled with its rate move on Wednesday, do not point to any obvious damage.

The US is now seen as growing by 3.1 per cent this year, up from 2.8 per cent previously, before the expansion eases to 2.5 per cent in 2019 and 2 per cent in 2020 – slightly faster than its estimated long-run pace of 1.8 per cent.

Fed policymakers projected core inflation will rise to a median 2.1 per cent next year, unchanged from the previous estimate, and continue to slightly overshoot the central bank’s target as it remains at the same level in 2020 and 2021.

The latest median projection showed the Fed now expects the jobless rate to fall to 3.5 per cent, also in line with prior forecasts. That would be well below the Fed’s 4.5 per cent estimate of the longer-run rate of unemployment.

The decision to increase interest rates was endorsed by all of the current members of the FOMC, including Richard Clarida, the central bank's newly-installed vice-chairman. – Copyright The Financial Times Limited 2018