The Fed’s long-awaited increase

After months of speculation, the Fed has increased interest rates for the first time since 2006

Traders react to Fed rate increase
Chicago traders react to the news of the Fed's rise in interest rates 

The US Federal Reserve made a historic announcement on December 16, raising short-term interest rates for the first time in almost a decade. The decision is important in that it brings a swift and decisive end to the near-zero rate climate that has prevailed since 2008, when the global financial crisis forced the Fed and others to introduce record low rates.

The rise of 0.25 percent, though small, is significant for a global economy accustomed to record low borrowing fees and the decision may well encourage central banks around the world to follow suit. What’s worrying for developing countries is that the rise will impose higher costs, and there are fears already that the decision could hamper global economic growth.

There are fears already that the decision could hamper global economic growth

Nonetheless, the Fed said in a statement that considerable improvements to the labour market, together with an improved inflation outlook for the medium term, are reasons enough to justify the rise. “Given the economic outlook, and recognising the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 0.25 to 0.5 percent,” it said. “The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labour market conditions and a return to two percent inflation.”

The plan is to increase the rate gradually, so as not to inflict undue harm on emerging markets. In addition, the central bank will maintain the size of its balance sheet until the normalisation of interest rates firmly sets in. Policymakers will be eyeing the impact on equity markets as investors pull out of emerging markets in search of higher yields.

Within hours of the announcement, Wells Fargo became the first in a line of financial institutions, which also included JP Morgan Chase, CitiBank and SunTrust, to boost its prime interest rate. As such, favoured customers will pay a 3.5 percent base rate for consumer loans, rather than the 3.25 percent level that has been maintained for around seven years.

US interest rates are expected to increase again to 1.375 percent by the end of 2016, followed by further hikes over the next four or so years. Although lenders had sufficient time to prepare for December’s small rise, uncertainly is likely to grow, with each increase becoming more onerous for both consumers and the economy.