It could have been worse. That was Wall Street’s initial response to the decision by the US Federal Reserve to raise borrowing costs in the world’s biggest economy by a quarter of a point.

For once, the market reaction was entirely rational. The increase in interest rates was expected and it would have been a real surprise had Janet Yellen and her colleagues at the US central bank decided against a move.

Indeed, the strength of employment growth reported last week had led to speculation that the Fed might just be planning a half-point move. That would certainly have led to a sell-off in the stock market since it would have been a tacit admission that Yellen and the Fed were playing catch up.

US Federal Reserve raises interest rates to 1% in bid to hold off inflation Read more

Some economists think that is indeed the case – and that just as in the early 2000s the Fed is doing too little too late. They point to inflation running at 2.7% and an unemployment rate of 4.7% as evidence that price pressures have already started to build.

But the economic news has not all been upbeat. US growth was modest in the final three months of 2016 and the early evidence is that the first quarter of 2017 was no great shakes either. And while the unemployment rate is low, that is partly because millions of Americans have left the labour market altogether after giving up hope of ever finding work. The US is certainly not firing on all cylinders despite almost a decade of ultra-low interest rates and large dollops of money creation via the Fed’s quantitative easing programme.

Hence the key messages from Yellen on Wednesday were that rates will continue to rise but at a cautious pace. She stressed that the central bank expected the economy to grow at a rate that would warrant gradual increases in interest rates. That will be taken as a hint that there will be two more rises during the course of 2017.

The Fed has now raised interest rates three times in the past 15 months. Clearly, the period of ultra-low borrowing costs is at an end. The so-called normalisation of rates is under way.

But it is also obvious that the Fed sees the new normal as being quite different to the old normal. In the mid-2000s, Alan Greenspan’s Fed raised interest rates 17 times in gradual quarter-point jumps until they topped 5%. This time, the Fed sees rates peaking at a much lower level – about 3% – and as things stand they won’t get there until 2019.

In the short term, the steady increase in US interest rates will support an already strong dollar. One of the ironies of QE is that it was supposed to encourage investors to buy risky assets yet has led instead to a flight into safe havens such as the greenback and US bonds.

The growing differential between US rates and those in Japan, the eurozone and the UK will lead to further support for the dollar unless the American economy shows signs of weakness.

With Donald Trump planning tax cuts and spending increases, Wall Street currently sees that as unlikely. But Yellen is aware that Greenspan’s softly-softly approach to raising rates ended with an almighty financial crisis and the biggest US slump since the 1930s. She is keen to avoid a repeat performance.