Federal Reserve hikes interest rates for second time in three months

The Federal Reserve raised interest rates yesterday for the second time in three months, citing continued US economic growth and job market strength, and announced it would begin cutting its holdings of bonds and other securities this year.

The decision lifted the US central bank’s benchmark lending rate by a quarter percentage point to a target range of 1.00% to 1.25% as it proceeds with its first tightening cycle in more than a decade.

In its statement following a two-day meeting, the Fed’s policy-setting committee indicated the economy had been expanding moderately, the labour market continued to strengthen and a recent softening in inflation was seen as transitory.

The Fed also gave a first clear outline on its plan to reduce its $4.2tn (€3.7tn) portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession.

“The committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated,” the Fed said in its statement.

The central bank said it would gradually ramp up the pace of its balance sheet reduction and anticipates the plan would feature halting reinvestments of ever-larger amounts of maturing securities.

The Fed said the initial cap for Treasuries would be set at $6bn per month initially and increase by $6bn increments every three months over a 12-month period until it reached $30bn per month in reductions to its holdings.

For agency debt and mortgage-backed securities, the cap will be $4bn per month initially, increasing by $4bn at quarterly intervals over a year until it reached $20bn per month.

US stocks rose after the Fed announcement, while the dollar reversed some of its earlier losses.

“The Fed announcing an update to their reinvestment principles leaves September open. The start of balance sheet runoff and the fact that they haven’t slowed their projected path of rate hikes suggest they can do both balance sheet and rate hikes at the same time,” Gennady Goldberg, interest rate strategist at TD Securities said.

Fed chair Janet Yellen at a press conference last night, said the Fed believed the planned reduction in its $4.5tn balance sheet should be “gradual” and “predictable.”

“We continue to feel the economy is doing well,” she added.