After one of the longest, most telegraphed windups in monetary policy history, the Federal Reserve on Wednesday delivered a small brushback pitch to the American economy, raising its key lending rate by a quarter of a percentage point for the first time since 2006.
The move ends an extraordinary run in which the central bank held its borrowing rate at essentially zero for seven years in an effort to pump life into the American economy after the onset of the global financial meltdown and the Great Recession from December 2007 to June 2009.
Although Fed Chair Janet Yellen argued that the move marked a sign of economic stabilization, she cautioned that more rate increases next year should not be assumed.
“The first thing that Americans should realize is that the Fed’s decision today reflects our confidence in the U.S. economy, that we believe we have seen substantial improvement in labor market conditions,” Ms. Yellen told reporters shortly after the rate hike was announced Wednesday afternoon. “And while things may be uneven across regions of the country and different industrial sectors, we see an economy that is on a path of sustainable improvement.”
In addition to potentially raising the rates for consumers and businesses on trillions of dollars of car, home, student and commercial loans, the Fed move could play a major role in elections next year through its impact on the economic growth rate.
U.S. stock markets took the expected rate increase in stride, heartened by what was widely seen at Ms. Yellen’s dovish stance on future rate hikes and her concern that the Fed not choke off the U.S. recovery in the face of weakness in many of the world’s other leading economies.
Virtually flat when the Fed decision was being released, the three major U.S. stock markets all were up in the final hour of trading. The Dow Jones index of blue-chip stocks closed up 224.18 points, or 1.3 percent, to 17,749.09, and the broader S&P 500 index and the tech-heavy Nasdaq were up 1.5 percent.
Ms. Yellen and members of the Fed’s rate-setting committee were plainly eager to “normalize” the Fed’s interest rate policy and move away from the unnaturally low interest rates, even though U.S. and global inflation rates remained low. The Fed chair said she also worried that if the central bank did not act now, it would be forced to take a far more disruptive move later on.
Had the Fed waited, “we would likely end up having to tighten policy relatively abruptly at some point to keep the economy from overheating and inflation from significantly overshooting our objective,” Ms. Yellen said. “Such an abrupt tightening could increase the risk of pushing the economy into recession.”
House Financial Services Committee Chairman Jeb Hensarling said the Fed’s move was an acknowledgment that its easy-money stance failed to ignite a recovery under President Obama that has been tepid by U.S. historical standards.
“Getting back to sustainable, market-based interest rates is better for consumers, investors and our economy overall,” the Texas Republican said in a statement. “Unsustainably low interest rates clearly didn’t solve the problem or else Americans today wouldn’t be stuck in the slowest, worst-performing economic recovery of our lifetimes.”
But critics say the Fed moved too soon, raising rates when inflation is well below the central bank’s “target” of 2 percent and soft spots remain in the U.S. job market and wages are flat.
“When millions of Americans are working longer hours for lower wages, the Federal Reserve’s decision to raise interest rates is bad news for working families,” said Sen. Bernard Sanders of Vermont, a Democratic presidential contender.
“The Fed should act with the same sense of urgency to rebuild the disappearing middle class as it did to bail out Wall Street banks seven years ago,” Mr. Sanders said.
The effect of the Fed move for consumers was felt almost immediately as banking giants JPMorgan Chase and US Bancorp said they would raise their prime rates for top borrowers by 0.25 percentage points to 3.5 percent effective Thursday. Many other lending rates, including those for credit cards and auto loans, are tied to the prime rate.
The Fed move could be good news for savers, though, who have been getting paltry returns on their bonds and savings accounts.
Fed watchers said the central bank had little option but to make a move after a series of meetings this year that raised and then dashed expectations of a rate hike. Economists and investors overwhelmingly expected an increase.
If the Federal Reserve had not raised rates, it “would have had a massive credibility problem” Bob Doll, chief equity strategist at Nuveen Asset Management, told CNBC.
The Fed statement on its move talked of additional, “gradual” moves to increase rates in the months ahead if conditions warrant, but Ms. Yellen went out of her way not to tie the central bank to automatic increases. She said the Fed governors would be watching to see whether inflation pressures ease and whether problems in economies overseas threaten the U.S. recovery before approving more rate increases.
“‘Gradual’ does not mean mechanical,” she told reporters. “It certainly is not the intention of the committee to follow any mechanical formula of that type.”
Analysts said the overall image was of a cautious Fed still torn between the pressure to raise rates and a fear of choking off the economy too soon.
“The Fed is much more uncertain itself about what is going on in the economy and willing to express that,” Columbia University economics professor Charles Calomiris told The Associated Press.
The Fed “doesn’t have a very clear model of how the economy is functioning.”