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Financial markets took the first increase in US interest rates since 2006 largely in their stride, as the Federal Reserve fulfilled market expectations by implementing a 25 basis point rise in its policy rate.
After the Federal Open Market Committee unanimously voted to lift the cost of borrowing for the world’s largest economy from 0.25 to 0.5 per cent, the dollar index (which shows the value of the greenback against a basket of global currencies) first spiked to 98.5 before slumping to below 97.7.
Stocks were lifted, with the S&P 500 and the Dow Jones both trading up by around 1.4 per cent in the wake of the decision.
One of the biggest moves came in the West Texas Intermediate crude oil price, which fell more than 2 per cent to $35.30 a barrel, pushing closer to an 11-year low.
Traders and analysts focused on the relatively dovish wording of the Fed’s accompanying statement, which stressed that future rate rises would be “gradual” and that the policy rate would be “likely to remain” for some time below levels that are expected to prevail in the longer run “for some time”.
“It’s important not to overblow the significance of this first move” Ms Yellen said in her press conference in Washington after the decision. “We have very low rates and we’ve made a very small move”.
Mohamed El-Erian of Allianz said the Fed had embarked on “the loosest tightening in its history”. He added: “The Fed is going out of its way to assure markets that, by embarking on a ‘gradual’ path, this will not be your traditional interest rate cycle”.
Simon Derrick at BNY Mellon said: “Given the forces in play, most notably lower oil prices and a stronger dollar, this was to be expected.” He added that the Fed was being “careful not to disturb the markets’ equanimity”.
Ms Yellen said the 12-member Fed committee had “reasonable confidence” that inflation would return to the official 2 per cent target from its current 0.5 per cent level.
The Fed also released its latest economic forecasts, which showed little change from its last meeting. The Fed still expects the policy rate to be at 1.4 per cent at the end of next year. The forecast for the end of 2017 was revised down to 2.4 per cent, from 2.6 per cent previously.
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Some analysts argued that the Fed was underestimating the pace at which it would have to raise rates. Paul Ashworth of Capital Economics said: “Our view is still that inflation will rebound much more rapidly than the Fed believes in the first half of next year, as the deflationary pressure from lower commodity prices and the surge in the dollar begin to fade, while domestic price pressures continue to build.”
The pound had earlier slipped against the dollar after the Office for National Statistics reported that average wage growth slowed in the three months to November. The pound briefly fell below $1.5 as traders pushed back their bets on the timing of the next Bank of England rate rise.
However, research by Samuel Tombs of Pantheon Macroeconomics shows that over the past 30 years the Bank has been on average five months behind the Fed’s lead in raising rates.
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