Liftoff! Fed raises rates for first time since '06

Paul Davidson | USA TODAY

Show Caption Hide Caption Fed raises interest rates for first time since 2006 For the first time in nearly a decade, the Federal Reserve has raised interest rates. The move puts the federal funds rate at about 0.4% after being held near zero since the 2008 financial crisis.

WASHINGTON-- The nation's recovery from the Great Recession reached a historic milestone Wednesday as the Federal Reserve raised interest rates for the first time in nearly a decade, ending an extraordinary era of easy-money policy.

The modest ¼ percentage point increase in the Fed's benchmark rate was widely expected and accompanied by signals that Fed policymakers intend to nudge up rates even more gradually than anticipated the next few years. That's a nod to inflation that remains unusually low and vestiges of the downturn that continue to thwart a more vibrant economy.

The Fed's move puts the federal funds rate at about 0.4% after it has hovered near zero since the 2008 financial crisis as the Fed sought to spur more borrowing by consumers and businesses and juice often-sluggish growth.

"The economic recovery has clearly come a long way, though it is not yet complete," Fed Chair Janet Yellen said at a news conference after a two-day meeting. "We decided to move at this time because...we felt the conditions" of further improvement in the labor market and confidence that inflation will pick up to the Fed's annual 2% target "had been satisfied."

If the Fed had waited to boost rates, "We would likely end up having to tighten policy relatively abruptly to prevent the economy from overheating" and, eventually, a rapid climb in inflation. That, she says, could topple the U.S. back into recession.

In a statement, Fed officials added that interest rate policy "remains accommodative" to growth and they expect the economy to warrant "only gradual increases" the next few years. With inflation still well below the Fed's target, policymakers tellingly said they "will carefully monitor actual and expected progress toward its inflation goal." Previously, they said they simply need to be reasonably confident that inflation will accelerate to initially bump up rates.

But Yellen refused to say that inflation must accelerate before the next Fed hike and said future increases will be based on a a broad range of economic data, not set to a timetable. "I'm not going to give you a simple formula for what we need to see in order to raise rates again," she said.

Carl Tannenbaum, chief economist of Northern Trust and a former Fed official, doesn't expect the central bank to raise rates again until June, saying the recent tumble in oil prices will further suppress inflation next year.

"They're going to take their time," he says.

The Fed's vote was unanimous despite recent divisions among policymakers, some of whom preferred to wait until next year to hoist rates.

Fed policymakers, though, are forecasting an even shallower rise in the rate than they previously projected. Their median estimate is that it will increase to 1.4% by the end of 2016 and 2.4% by the end of 2017. As a result, interest rates are expected to remain unusually low for several years. Fed officials have emphasized that could change if inflation picks up more abruptly than projected.

By the end of 2018, the funds rate is still expected to be slightly below a long-run normal level of 3.5%. The Fed yanked up rates about twice as rapidly during the previous three recoveries.

Michael Gapen, chief US economist at Barclays Capital and a former Fed staffer, has said the forecast for tempered increases is aimed partly at mollifying pro-growth policymakers hesitant to lift rates and calm financial markets nervous that the withdrawal of the Fed's easy money could douse the six-year bull market.

Wednesday's rate increase, along with subsequent anticipated hikes the next few years, are likely to ripple across the economy, modestly boosting rates on everything from mortgages and student loans to corporate bonds and bank savings accounts. The Fed's aim: slightly tamp down economic activity and prevent inflation from overheating as the near-normal 5% unemployment rate and a shrinking pool of available workers begin to put upward pressure on wages.

The Fed left its forecast for economic growth this year unchanged at 2.1% but slightly increased its estimate for 2016 to 2.4%. Policymakers also expect unemployment to fall to 4.7% by the end of next year, slightly below their previous forecast.

Notably, the Fed said labor market slack, such as part-time workers who prefer full-time jobs, "has diminished appreciably since early this year."

"The first thing Americans should realize is that the Fed's decision today reflects our confidence in the US economy," Yellen said.

Yet the officials also modestly revised down their inflation forecast for next year to 1.6%.

Even in recent weeks, Fed policymakers remained split over whether the economy is finally ready for higher rates. On the one hand, the unemployment rate has fallen sharply from 10% in 2009 and monthly job growth has averaged well over 200,000 the past two years, developments that led Fed Chair Janet Yellen to state that a rate increase was likely before the end of 2015.

Still, many Americans continue to work part-time even though they prefer full-time jobs or have given up looking for work, though the ranks of such Americans have fallen. Partly as a result of this surplus labor supply, wage growth has only recently shown signs of accelerating beyond the tepid 2% annual pace that has prevailed throughout the recovery.

Broader inflation has been stuck well below the Fed's annual 2% target, both because of meager pay gains as well as low oil prices and a strong dollar that has kept imports cheap for U.S. consumers. The Fed reiterated Wednesday that it expects energy prices and the dollar to stabilize.

In September, the Fed's hand was stayed by global economic troubles, which has combined with the rallying greenback to clobber exports, and related market turbulence.

Citing those forces and feeble inflation, several Fed policymakers argued for caution, saying the risks of moving too soon and derailing a still-vulnerable recovery outweighed the hazards of waiting and possibly having to raise rates more rapidly to catch up to inflation.

Since October, though, the mood has shifted. China's economic troubles eased somewhat and failed to spread to other emerging markets, stock markets rallied, and U.S. job growth rebounded strongly in October and November from a late-summer slump.

The rate increase marks yet another landmark in the recovery from the 2007-09 downturn, the worst since the Great Depression. In fall 2014, the Fed ended an unprecedented bond-buying stimulus that pumped about $4 trillion into bank offers and pushed down long-term interest rates.

Those assets remain on the Fed's balance sheet and Fed officials have said they won't sell them -- an effort to provide further stimulus to the economy and avoid disrupting markets. Instead, the Fed has said it eventually will allow the bonds to roll off its books as they mature, instead of reinvesting them.

Because of the vast cash in the banking system, the Fed can't adjust its funds rate by selling securities to shrink bank reserves, as it has historically done. Instead it's using new tools that provide interest to banks and money market funds to park cash at the central bank. Theoretically, at least, the firms should not lend at a rate below a risk-free return from the Fed, though the tools have not been used before. Economists say the Fed may not be able to control the funds rate as precisely as it did before, possibly causing some short-term market volatility.

To ensure a smooth liftoff, the Fed on Wednesday suspended a $300 billion cap on investments for money market funds and other non-banks.

Wow: Jim Grant tells @Kelly_Evans why the Fed will REVERSE COURSE on rates (@CNBC video) https://t.co/MmC5c39yCM pic.twitter.com/j1gCMK1sV6 — USA TODAY Money (@USATODAYmoney) December 16, 2015

Paul Davidson on Twitter: @PDavidsonusat.