Fed decision: Federal Reserve hikes rates to range of 1.75% to 2%, ups forecast to 4 hikes in '18

Paul Davidson | USA TODAY

Show Caption Hide Caption Fed chair Jerome Powell on strong outlook, new rates forecast Jerome Powell testified before Congress Tuesday, his first public appearance as chairman of Federal Reserve. Powell delivered the semi-annual monetary policy report before the House Financial Services Committee, expressing a positive outlook. (Feb. 27)

WASHINGTON – The economy is revving up, and so the Federal Reserve is stepping up its plan to move interest rates closer to normal.

As anticipated, the Fed raised its benchmark short-term interest rate Wednesday but it also upgraded its forecast from a total of three hikes this year to four amid an improving economy, falling unemployment and slightly stronger inflation.

The move is expected to cascade through the economy, in particular nudging up rates for variable-rate consumer loans such as credit cards and adjustable-rate mortgages.

It’s also likely to push up bank savings rates for Americans, especially seniors, who are finally realizing higher returns on CDs, bonds and other fixed-income assets after years of meager yields.

"The main takeaway is the economy is doing very well," Fed Chairman Jerome Powell said at a news conference. "Most people who want to find jobs are finding them."

The central bank lifted its federal fund rate – what banks charge each other for overnight loans – by a quarter percentage point to a range of 1.75 percent to 2 percent. That’s within shouting distance of its longer-run forecast of 2.9 percent. It’s the second rate hike this year and the seventh since the Fed began bumping up rates amid an improving economy in late 2015.

For years after the Great Recession of 2007 to 2009, the Fed kept its key rate near zero to stimulate sluggish growth.

In perhaps a telling sign, the Fed removed its previous assertion that its key rate “is likely to remain, for some time, below levels that are expected to prevail in the longer run.” That suggests the Fed could push up rates more rapidly. Powell, however, said it simply means rates are getting closer to normal levels.

The reaction in financial markets to the Fed’s latest move was relatively muted Wednesday, although stocks and bond prices fell.

The Dow Jones industrial average, which had been down about 10 points before the Fed announcement, ended down 120 points, or 0.5 percent, at 25,201. Government bonds sold off as fixed-income investors begin to price in even higher rates than they had previously expected later this year. The 10-year Treasury yield, a benchmark for long-term rates, edged up from 2.947 percent before the Fed news to 2.976 percent. It is still well below its 2018 high of 3.113 percent from May 17.

How fast rates will rise

The big question ahead of Wednesday’s meeting was whether the Fed would keep its forecast for three quarter-point increases this year or bump it up to four. It raised it to four but maintained its projection of three more hikes in 2019.

The Fed expects its key rate to rise to 2.4 percent at the end of the year, up from its prior estimate of 2.1 percent, reckoning unemployment will fall a bit faster than it previously thought and inflation will kick up a bit more, according to its median forecast. Eight of 15 officials now expect four hikes, up from seven in March.

It now expects the rate will be 3.1 percent at the end of 2019, up from its previous projection of 2.9 percent. The forecast indicates Fed policymakers expect federal tax cuts and spending increases to juice growth.

The economy

The Fed predicts the economy will grow 2.8 percent this year, up from its March forecast of 2.7 percent, and it maintained its 2.4 percent estimate for 2019.

“Economic activity has been rising and a solid rate,” the Fed said in a statement after a two-day meeting.

The economy grew at a 2.2 percent annual rate in the first quarter, in line with its modest average throughout the 9-year-old economic expansion. But growth is expected to pick up to about 4 percent in the current quarter and average close to 3 percent this year.

While the federal tax cuts and spending increases are goosing the economy, the Trump administration’s widening trade standoffs with other nations could slow growth by next year if proposed tariffs and tit-for-tat responses are carried through, economists say.

Jobs

The Fed estimates the 3.8 percent unemployment rate will fall to 3.6 percent by the end of the year and 3.5 percent by the end of 2019, below its March forecast of 3.6 percent. “Job gains have been strong, on average, in recent months, and the unemployment rate has declined,” the statement said.

Since the Fed last met in mid-March, unemployment has fallen from 4.1 percent to an 18-year low of 3.8 percent. That could spur faster wage gains and inflation as businesses compete more intensely for fewer available workers. And that’s likely spurring the Fed to signal a slightly faster boost in rates.

Inflation

Amid the improving economy, inflation has picked up lately and Fed policymakers are looking for a slightly faster gain that leaves annual consumer price increases slightly above the Fed’s 2 percent target, though just marginally.

The Fed said Wednesday it expects annual inflation to rise from 2 percent to 2.1 percent by the end of the year, up from its previous estimate of 1.9 percent, and 2.1 percent at the end of 2019, up from 2 percent. It expects a core measure that strips out volatile food and energy items to edge up from 1.8 percent to 2 percent at the end of the year, up from its previous 1.9 percent estimate. But it didn’t change its prediction that core inflation will hold steady 2.1 percent in 2019 and 2020.

Overall, inflation remains largely contained. Many economists cite long-term factors such as the more global economy, e-commerce, the decline of unions and weak gains in the average worker’s output.

Still, Powell said, "After many years of inflation below our objective, we do not want to declare victory."

What it means

The Fed is trying to raise rates enough to head off an eventual leap in inflation without derailing the recovery. The Fed appears to believe the falling unemployment rate could spur faster inflation and it’s no longer treating the economy with kid gloves.

"The Fed is moving towards the point where it believes it might have to be positively seeking to restrain growth," says Ian Shepherdson, chief economist of Pantheon Macroeconomics.