The Federal Reserve has kept interest rates steady but approved a historic plan to begin unwinding its massive balance sheet, in a big step on the way towards the so-called normalisation of US monetary policy.
In a statement released today the US central bank said the heavily telegraphed balance sheet unwinding programme will start in October. Fed chair Janet Yellen today said the unwinding will be a "gradual and predictable".
Under the plan, the Fed will gradually reduce the $4.5 trillion pile of securities amassed during the quantitative easing stimulus programme by gradually stopping the reinvestment of the money from maturing bonds, letting the bonds roll off the balance sheet without actively selling them.
Meanwhile, the policy-setting Federal Open Markets Committee voted to keep the federal funds rate, at which the Fed lends to other banks, at a target range of one to 1.25 per cent.
However, the FOMC's closely scrutinised "dot plot", an indication of how far its economists expect to raise interest rates, indicated they are still preparing for one more hike this year, despite weak inflation. The FOMC meets twice more in 2017, at the start of November and in December.
The FOMC's statement noted it is "monitoring inflation developments closely". Inflation in the US remains well below its two per cent target, with recent softness giving pause to the central bank in the middle of a cycle of hiking interest rates.
The central bank warned the damage caused by multiple hurricanes in the south west of the US, which has resulted in higher petrol prices, could cause a temporary rise in inflation. However, it did not expect those effects to be permanent.
Antoine Lesne, head of strategy and research for SPDR ETFs, said: “While widely predicted and telegraphed over the past month the Federal Reserve is moving from talking to acting. It is the first central bank to start the unwinding process."
He added: "Despite less impressive economic numbers and the likely impact of hurricanes Harvey and Irma, the Fed seems to be confident the US economy can withstand a more hawkish and quicker tightening of monetary conditions."
Tom Stevenson, investment director for personal investing at Fidelity International, said: "Today’s chart continues to suggest that the Fed will press ahead with one more quarter-point interest rate hike by the end of the year and three further quarter point hikes in 2018. This will provide some support for the dollar, which has weakened in 2017 on expectations for lower for longer US interest rates."
The Fed's moves were as expected, but "quantitative tightening" – the opposite of quantitative easing – could cause some market volatility, according to Kully Samra, UK managing director of asset manager Charles Schwab.
He said: "Given the tightness of both the labour and housing markets, inflation could begin to surprise on the upside, perhaps pushing the Fed to act more aggressively than the consensus anticipates.”
The Federal Reserve's economic projections see GDP growth slowing to an annual rate of 1.8 per cent in 2020, the last year of the presidency of Donald Trump, from an expected rate of 2.4 per cent growth in 2017.
US Treasury yields rose to their highest level in a month after the announcement as investors sold off the bonds, reaching a high of 2.282 per cent at the time of publication, according to Tradeweb. Bond yields move inversely to prices.