Fed finally lifts key interest rate from near zero

Wednesday, all ten members of the central bank’s Federal Open Market Committee voted for the rate increase, the Federal Reserve said in a news release – even though three of them had expressed concern in recent weeks that a hike may yet not be in the economy’s best interest.

The Fed coupled its first rate hike in nine years with a signal that further increases will likely be made slowly as the economy strengthens further and inflation rises from undesirably low levels.

In addition to Wednesday’s hike of the federal funds rate, the Fed said gradual increases to the benchmark are expected to happen throughout 2016 – as long as the economic outlook continues on target.

The Dow Jones industrial average, which was up about 75 points just before the Fed announcement, ended the trading day with a gain of 224 points, at 17,749.

An obscure federal agency raising an obscure interest rate might not seem like big news.

The Fed’s target for inflation is 2 percent, but right now its close to zero. 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.

But the Labor Department’s most recent read of inflation Tuesday showed that over the past 12 months, the Consumer Price Index has risen by 0.5 percent, well below the 1-2 percentage range sought by the Fed. The decision removes a giant question mark about Fed policy that had been hovering over Wall Street for months.

Fed officials’ expectations for the economy didn’t change much. With unemployment at a low 5 percent, Fed officials decided that the economy is strong enough after seven years of record-low rates to withstand modestly higher borrowing rates.

The relatively strong USA economy along with the anticipation of higher interest rates has allowed the dollar to strengthen significantly against rival currencies this year. The yield on the 10-year Treasury note held steady at 2.27 percent. That rate represents the upper end of the fed funds range, at 0.5 percent.

Investors’ immediate reaction to the Fed’s announcement, which was widely anticipated, was muted as stocks moved slightly up.

Normally, the Fed raises rates when it worries that the economy is overheating. It raised the rate it pays on a type of short-term loan to 0.25 percent from 0.05 percent. “I think we can use a great Star Wars analogy and say that “the force” will awaken and the Fed will raise that quarter percent today”, said Jeff Carbone, managing partner of Cornerstone Financial Partners.

“And this would be much more serious than a modest uptick in inflation because it’s not at all clear what the Fed could do to fix its mistake”.