The US Federal Reserve raised its benchmark interest rate on Wednesday for the second time in three months and signalled that any further rises this year would be gradual.
The move reflects a consistently solid US economy and will affect Arabian Gulf economies with currencies pegged to the dollar.
The Fed’s key short-term rate is rising by a quarter-point to a still-low range of 0.75 per cent to 1 per cent.
Even this small increase in the domestic cost of lending for American banks will push up borrowing costs the world over, as central banks tied to the dollar are forced to follow suit – or experience speculative pressure on their exchange rates.
The UAE, Qatar, Saudi Arabia, Bahrain and Oman all have currencies pegged to the dollar.
The US central bank’s rate increase was spurred by steady economic growth, strong job gains and confidence that inflation was rising to the bank’s target. Investors had widely expected the rate increase.
However, the Fed’s policy-setting committee did not flag any plan to accelerate the pace of monetary tightening. Although inflation is close to the Fed’s 2 per cent target, it noted that goal was “symmetric”, indicating a possible willingness to allow prices to rise at a slightly faster pace.
After the announcement, US stocks added to gains, Treasury yields fell and the dollar weakened slightly. “The angst out there in the market was the Fed was going to come out swinging. There was none of that in the statement,” said John Canally, investment strategist and economist at LPL Financial in Boston. “The rate hike was priced in and we got it.”
The message the Fed is sending is that nearly eight years after the Great Recession ended, the US economy no longer needs the support of ultra-low borrowing rates and is healthy enough to withstand steadily tighter credit.
Investors had seemed unconcerned in recent weeks by the possibility that the Fed would raise rates several times in the coming months
Instead, Wall Street has been sustaining a stock market rally that began with president Donald Trump’s election in November, buoyed by the prospect that tax cuts, an easing of regulations and higher spending for infrastructure would accelerate growth.
A robust February jobs report – 235,000 added jobs, solid pay gains and a dip in the unemployment rate to 4.7 percent – added to the perception that the US economy appears fundamentally strong.
That the Fed is no longer unsettling investors with the signal of a forthcoming rate increase marks quite a change from the anxiety that prevailed after 2008, when the central bank cut its key rate to a record low and kept it there for seven years.
During those years, any slight shift in sentiment about when the Fed might begin raising rates – a step that would lead eventually to higher loan rates for consumers and businesses – was enough to move global markets.
In 2013, chairman Ben Bernanke sent markets into a panic merely by mentioning that the Fed was contemplating slowing the pace of its bond purchases, which it was using then to keep long-term borrowing rates low.
But now, the US economy is widely considered sturdy enough to handle modestly higher loan rates. Inflation, which had stayed undesirably low for years, is edging near the 2 per cent annual rate that the Fed views as optimal.
And while the broadest gauge of the US economy’s health – the gross domestic product – remains well below levels associated with a healthy economy, many analysts say they’re optimistic that Mr Trump’s proposed tax cuts, infrastructure spending increases and deregulation may accelerate growth.
Those proposals have lifted the confidence of business executives and offset concerns that investors might otherwise have had about the effects of Fed rate increases.
Yet for the same reason, some caution that if Mr Trump’s programme fails to survive Congress intact, concerns will arise that the president’s plans won’t deliver much economic punch. Investors may start to fret about how steadily higher Fed rates will raise the cost of borrowing and slow spending by consumers and businesses.
The Fed usually raises rates to prevent an economy from overheating and inflation from rising too high. But throughout the Fed’s history, its efforts to control inflation have sometimes gone too far – slowing borrowing and spending so much as to trigger a recession. Already, the current expansion, which officially began in 2009, is the third-longest since the Second World War.
* Associated Press
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