Fed raises rates, keeps forecast for 3 hikes in 2018

Paul Davidson | USA TODAY

Show Caption Hide Caption How the Federal Reserve raising interest rates will affect you USA TODAY's Adam Shell tells us what to expect following the increase in interest rates on March 21.

WASHINGTON — Citing a brighter economic outlook, the Federal Reserve raised its key short-term interest rate Wednesday but maintained its forecast for a total of three hikes this year amid still-modest inflation.

The move is expected to ripple through the economy, nudging consumer and business borrowing costs higher, especially for variable-rate loans such as adjustable-rate mortgages and credit cards.

Investors cheered the unchanged rate forecast for 2018, pushing up the Dow Jones industrial average about 250 points initially before stocks pared their gains.

The Fed’s policymaking committee, as widely anticipated, lifted the federal funds rate — what banks charge each other for overnight loans — by a quarter percentage point to a range of 1½% to 1¾%.

More: How Federal Reserve rate hike will affect mortgages, auto loans, credit cards

That’s still low by historical standards but it marks the central bank’s fourth rate increase in the past 12 months and another vote of confidence in an economy that’s picking up steam nearly nine years after the Great Recession ended.

"We're trying to take that middle ground" on rate hikes, boosting rates enough to head off an eventual spike in inflation without derailing the economic expansion, Fed Chairman Jerome Powell said at a news conference. The meeting was the first led by Powell, a Republican and Trump appointee, who took the reins from Democrat Janet Yellen last month.

A breakdown of how the Fed sees:

How fast rates will rise

Wednesday’s rate hike was all but certain. Most of the suspense centered on whether the Fed would bump up its forecast from a total of three quarter-point increases this year to four. It held steady at three but raised its projection from two to three hikes next year as inflation picks up.

The Fed expects its key rate to climb to about 2.1% at the end of the year and 2.9% by the end of 2019 and over the longer run. It still expects “further gradual” rate increases.

With federal tax cuts and increased spending set to juice growth over the next couple of years, some analysts expected policymakers’ median projection to factor in an additional hike in 2018. That could have unnerved already volatile markets. But surprisingly tame consumer price increases likely convinced Fed officials to stand pat, at least for now.

The Fed raises rates to head off excessive inflation and lowers them to spur faster growth.

The economy

The Fed foresees the economy growing faster than it did in December. It expects growth of 2.7% this year, up from its December forecast of 2.5%, and 2.4% in 2019, up from its prior 2.1% estimate. Both top the tepid 2.2% average during the nearly 9-year-old recovery.

“The economy is healthier than it's been since before the (2008) financial crisis," Powell said,

The Fed statement said, "The economic outlook has strengthened in recent months,” an apparent nod to the $1.5 trillion Republican tax cuts and a budget blueprint that increases federal spending by $320 billion over the next decade.

The stimulus measures are poised to further jolt an economy that had already gained momentum, expanding at more than a 3% annual pace in the second half of 2017 on solid job and income growth and a strong global economy.

But while the Fed said economic activity has been rising “at a moderate rate,” it added that growth in consumer spending and business investment “have moderated from their strong fourth-quarter readings.”

Some economists worry the tax cuts and additional federal spending eventually could drive up inflation too quickly and add to the $21 trillion national debt — both of which could push interest rates higher, eventually curtailing borrowing and economic activity.

Trump's policies

Powell voiced doubt about Trump's vow to grow the economy 3% on a sustained basis. "That's well above almost all estimates," he said.

But Powell also downplayed concerns that Trump's sweeping steel and aluminum tariffs will hobble growth. "There's no thought (among Fed policymakers) that changing trade policy should have any effect on the current outlook," Powell said, unless the current trade conflict escalates significantly.

Jobs

The Fed said the “labor market has continued to strengthen,” adding that “job gains have been strong in recent months, and the unemployment rate has stayed low.”

Employers added more than 200,000 jobs in January and a booming 313,000 in February. Policymakers expect the 4.1% unemployment rate to fall to 3.8% by the end of the year, below their previous forecast of 3.9% and 3.6% by the end of 2019, below their prior estimate of 3.9%.

Very low unemployment is likely to accelerate tepid wage growth as employers compete for fewer available workers. And companies that lift worker pay ultimately increase consumer prices to maintain profits.

Inflation

Inflation has been the big conundrum. Despite the solidly growing economy, the Fed noted that annual inflation has continued to run below the Fed’s 2% target. It reiterated, however, that inflation “is expected to move up in coming months and to stabilize” around the Fed’s 2% benchmark “over the medium term.”

Policymakers expect annual inflation to rise from 1.7% to 1.9% by year-end and 2% by the end of 2019, unchanged from their December forecast. They still expect a core measure that strips out volatile food and energy items to increase from 1.5% to 1.9% by year-end, but slightly pushed up their forecast for the end of 2019 to 2.1%. In short, inflation won’t reach the Fed’s 2% goal until next year.

While the Fed generally wants to keep a lid on consumer price increases, sluggish inflation can signal a listless economy and pose a risk of falling prices that can hurt economic growth. Some economists point to long-term factors that have held down prices, such as the globally-connected economy and e-commerce.

Markets

The Dow Jones industrial average, which had been up about 130 points prior to the Fed announcement, initially jumped to a 250 point gain after the news. It then settled back to just a 13-point gain for by mid-afternoon. The 10-year Treasury bond yield, a benchmark for long-term rates, edged up marginally, from 2.89% to 2.91%.

Still, investors liked the status quo rate forecast for this year. Stock prices tend to dive at the prospect of higher interest rates because they make lower-risk bonds relatively more attractive. Higher rates can also crimp lending and the economy.

Markets expect the Fed to gradually raise rates, but a boost in the Fed’s forecast to four hikes this year may have spooked investors who are already on edge. The unchanged rate forecast for 2018 allayed those worries.

What it means

Fed officials are struggling to balance an economy that appears poised to heat up with inflation that has remained puzzlingly docile.

So far, they’re taking a middle-ground approach and lifting rates gradually – at least until inflation ratchets higher, a development some economists expect later in the year.

Scott Anderson ,chief economist of Bank of the West, says Powell's bullish view of the economy raises the odds for four rate hikes this year. Seven Fed policymakers now expect that many, up from four in December, he notes.

"I think it's a more confident (Fed) about where the economy is going to be," Anderson says.