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The Federal Reserve on Wednesday raised a key U.S. interest rate and signaled a somewhat more aggressive stance in 2018, underscoring the central bank’s confidence in a steadily growing economy but acknowledging the recent rise in inflation.
The bank as expected lifted its benchmark federal funds rate by a quarter-percentage point — to a range of 1.75% to 2%. Yet the Fed also signaled a small shift in its thinking by projecting a total of four rate increases in 2018 instead of three as previously planned.
Stocks (DOW:DJIA) turned lower and the yield on the 10-year Treasury note (XTUP:BX:TMUBMUSD10Y) moved higher after the decision.
The move did not reflect a major departure, however, in the Fed’s strategy of gradually raising interest rates to keep the economy on an even keel. The “dot plot” shows only one official switched to a slightly higher interest-rate path.
What’s more, Fed leadership remains closely divided over whether the bank should boost rates three or four times this year. Eight Fed officials said they expected interest rates to rise at least four times; seven forecast three rate hikes.
“The revised dots show that officials were mostly divided in whether there will be one or two more rate increases in 2018,” said Raymond James chief economist Scott Brown.
The lack of consensus reflects uncertainty about how high inflation will rise and how far the Fed can go before it damages the economy.
“If you raise rates too quickly, you are just increasingly the likelihood of recession,” Fed Chairman Jay Powell said in a press conference after the Fed move.
The Fed’s preferred inflation barometer, the PCE index, has already hit the bank’s long-run 2% target. Yet the Fed predicts inflation will end up around 2.1% by year end, suggesting central bankers think prices will ease later this year.
What the Fed has found particularly surprising is the slow rate of increase in worker pay despite the lowest unemployment rate in almost two decades and growing shortages of skilled labor.
“It’s a bit of a puzzle. I wouldn’t say it’s a mystery,” said Powell, who announced he will hold a press conference after all eight meetings of the Federal Open Market Committee each year instead of every other meeting. The FOMC is the arm of the Fed that actually sets interest rates.
With the economy on its firmest footing in years, the Fed made several changes to the statement to reflect just how much it’s improved. See the June FOMC statement
Most notably, gone is language that said the Fed expected the federal funds rate was “likely to remain, for some time, below levels that are expected to prevail in the longer run.” That’s a clear sign the Fed no longer thinks money is very cheap or that the economy needs as much help as it once did.
“The economy is in great shape,” Powell said.
Beyond this year, the Fed predicts it will raise rates three times in 2019 and one time in 2020 to push its benchmark rate up to 3.4%. Eventually the rate is expected to slip back to around 3% or a touch less.
In a twist, the Fed raised the interest rate on excess reserves by only 20 basis points to 1.95%. The central bank first signaled the possible tweak in the minutes of its most recent policy meeting released last month.