Fed raises interest rates for first time in a decade in 'dovish hike'

The Fed made clear that the rate hike was a tentative beginning to a "gradual" tightening cycle

The Federal Reserve hiked interest rates for the first time in nearly a decade on Wednesday, signaling faith that the US economy had largely overcome the wounds of the 2007-2009 financial crisis.

The US central bank's policy-setting committee raised the range of its benchmark interest rate by a quarter of a per centage point to between 0.25 per cent and 0.50 per cent, ending a lengthy debate about whether the economy was strong enough to withstand higher borrowing costs.

"The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise over the medium term to its 2 per cent objective," the Fed said in its policy statement, which was adopted unanimously.

The Fed made clear that the rate hike was a tentative beginning to a "gradual" tightening cycle, and that in deciding its next move it would put a premium on monitoring inflation, which remains mired below target.

"In light of the current shortfall of inflation from 2 per cent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate," the Fed said.

New economic projections from Fed policymakers were largely unchanged from September, with unemployment anticipated to fall to 4.7 per cent next year and economic growth at 2.4 per cent.

The statement and its promise of a gradual path represents a compromise between those who have been ready to raise rates for months and those who feel the economy is still at risk.

The median projected target interest rate for 2016 remained 1.375 per cent, implying four quarter-point rate hikes next year.

To edge that rate from its current near-zero level to between 0.25 per cent and 0.50 per cent, the Fed said it would set the interest it pays banks on excess reserves at 0.50 per cent, and said it would offer up to $2 trillion in reverse repurchase agreements, an aggressive figure that shows its resolve to pull rates higher.

Financial markets had expected the rate hike, bolstered by recent US data showing job growth continuing at a strong pace.

A December. 9 Reuters poll showed the likelihood of a hike on Wednesday was 90 per cent, with economists forecasting the federal funds rate to be 1.0 per cent to 1.25 per cent by the end of 2016 and 2.25 per cent by the end of 2017.

The rate hike sets off an immediate test of new financial tools designed by the New York Fed for just this occasion, as well as a likely reshuffling of global capital as the reality of rising US rates sets in.

The impact on business and household borrowing costs is unclear. One of the issues policymakers will watch closely in coming days is how long-term mortgage rates, consumer loans and other forms of credit react to a rate hike meant not to slow an economic recovery but nurse monetary policy back to a more normal footing.

The Fed emphasized it would move gingerly into its tightening cycle. That was enough to produce a unanimous vote on the policy-setting Federal Open Market Committee, as even members who had argued publicly for delaying a rate hike delay went along with Fed Chair Janet Yellen and other policymakers.

Image: US Federal Reserve Board chair Janet Yellen. Photograph: Gary Cameron/Reuters