Do Fed rate hikes have an effect on the US economy? The Federal Reserve announced a 0.25% increase in the interest rate Wednesday, its first increase since March. The US inflation rate was targeted to 2% this year, but it will likely fall below this.
Prices for items other than energy and food increased by 1.7% from May 2016. This core inflation level has been forecast to be 2% for 2018 and 2019. But will it be? There is conflicting evidence on the effect of Fed rate hikes on the US economy.
After the FOMC meeting (Federal Open Market Committee) Wednesday, the new interest rate range will be 1.0% – 1.25%. This new rate will affect adjustable debt and revolving debt. Examples of these are home equity loans and credit cards. There will also be an immediate effect on the baseline interest rate used by banks.
The chances of more Fed rate hikes this year are lower than they were. It was put at 50/50 Tuesday but now stands at 35%. Although higher than immediately prior to the statement, most believe that this will be last of this year’s rate hikes.
In addition to the interest rate statement, the Fed also stated that it intended to begin reducing its holding of Treasury bonds, mortgage-backed securities and other items on its $4.5 trillion balance sheet. Most of these were originally purchased during the housing crisis and recession to keep interest rates low.
It expects to run off an increasing amount of agency and mortgage debt in monthly stages until a maximum of $20 billion monthly is reached. Treasury bonds will be offloaded at an increasing rate of $6 billion until $30 billion monthly is reached. After that, the combined $50 billion run-offs per month would continue until the balance sheet reaches a reduced level of $2 trillion to $2.5 trillion.
This combination of reducing the Fed balance sheet and the interest rate increase will tighten the US economy. However, the timing of this balance reduction has yet to be stated. It is expected to be sometime this year. The combination of low unemployment and a low inflation rate is unusual. Retail spending dropped by the greatest amount for 16 months and consumer prices also fell.
Growth in the US is unlikely to reach President Trump’s figure of 3%. The Federal Reserve reckons that the US GDP will grow by 2.2% this year. This is higher than the March forecast of 2.1%. The jobless figure is also expected to be less than the 4.5% it has been. In broad terms, it’s wait and see, but the US economy seems to be in good hands. Fed rate hikes may make the US economy safer.
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