US Federal Reserve raises interest rates to target rate of 0.5 to 0.75 per cent, with "gradual increases" to come in 2017

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Janet Yellen Addresses The Economic Club Of New York
Janet Yellen chairs the Federal Open Market Committee (Source: Getty)

The US Federal Reserve has raised interest rates and set the scene for a further tightening of monetary policy throughout 2017.

Rate-setting body the Federal Open Market Committee (FOMC) raised the target range for its federal funds rate to 0.5 to 0.75 per cent.

The median expectation of FOMC members for tightening showed three further increases of 0.25 per cent over the course of 2017. It attempted to temper expectations of a sharp tightening, saying it "expects that economic conditions will evolve in a manner that will warrant only gradual increases."

FOMC chair Janet Yellen said: "Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made."

However, she said: "We're operating under a cloud of uncertainty at the moment", before President-elect Donald Trump's fiscal policies came into effect.

Trump's policies had an affect on the rate expectations, Yellen said: "Some of the participants did incorporate an assumption of a change in fiscal policy."

The FOMC said: "Near-term risks to the economic outlook appear roughly balanced", echoing exactly sentiments from the last meeting in November.

The FOMC in its statement noted the improving economic conditions: "the labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year."

The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further.

A rise was widely expected, with calculations by CME Group’s FedWatch Tool indicating a 92.9 per cent chance of an interest rate two hours before the decision.

Luke Bartholomew, investment manager at Aberdeen Asset Management, said: “The economy is in a more advanced stage of recovery and market pricing reflects this. We can expect rates to slowly climb through next year and beyond.”

However, significant uncertainty remains, with Donald Trump's fiscal policies still to be announced in detail.

“Trump is the big known unknown," said Bartholomew. "If there is a large fiscal stimulus then this will almost certainly create inflationary pressure that the Fed will have to fight by raising rates. It’s far from clear how big any stimulus will be and what impact it will have. The Fed is as much in the dark about this as the rest of us.”

Nancy Curtin, chief investment officer, at Close Brothers Asset Management, said: "The outlook is still finely balanced. Though unemployment is at a nine year low, wages and the participation rate have recently come in flat, which should give some reason for caution. The economy is not yet firing on all cylinders."

"Nevertheless, given the wait for a rate rise, today’s move should be seen as a vote of confidence in the US economy,” she added.

Read more: Will the US Federal Reserve hike interest rates more aggressively in 2017?

Members of the FOMC repeatedly telegraphed their intention to raise rates further. Chair Janet Yellen had previously said that a rise should come “relatively soon”, while saying that delaying rises would result in a sharper adjustment later.

The latest dot plot shows a cluster around the 1.25 to 1.5 per cent range for 2017

The previous “dot plot”, which indicates individual FOMC member views on the appropriate target range over the longer term, showed seven out of seventeen desiring a target range of one to 1.25 per cent over the course of 2017.

The rise is only the second in the last 10 years, as the US has followed a policy of historically low interest rates in an attempt to stimulate an economic recovery following the global financial crisis.

The federal funds rate determines the rate at which money deposited at the Federal Reserve can be lent to other banks.

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