Ahead of the Fed: Interest rate hike due on Wednesday

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First interest rate rise in seven years expected despite moderate US economic growth

​by Andrew Jay Rosenbaum

ANKARA – Although all of the targets set by the Federal Reserve for an interest rate hike have not been met, the central bank is expected to raise interest rates by 0.25 percent on Wednesday – the first rate increase in seven years.

The benchmark federal funds rate is expected to go from 0.25 percent to 0.50 percent.

The move by the Federal Open Market Committee, which will make the decision, is forecast by a vast majority of economists despite moderate growth and low inflation in the U.S.

Over the last 12 months, the inflation rate has reached just 0.5 percent annual rate in November, according to a report by the Labor Department on Tuesday. The Fed’s target for inflation is close to 2 percent.

But core inflation, which strips out food and energy, was at an annual  2 percent in November according to the report.

But in a speech on Dec. 2, Federal Reserve governor Janet Yellen said that the Fed expected inflation to reach the target level “over the next two years”.

“I anticipate continued economic growth at a moderate pace that will be sufficient to generate additional increases in employment, further reductions in the remaining margins of labor market slack, and a rise in inflation to our 2 percent objective,” Yellen said.

 Over the first three quarters of this year, U.S. real GDP is currently estimated to have advanced at an annual rate of about 2 percent, and economists forecast a similar rate of growth in the fourth quarter.

Consumer spending and business investment has grown more rapidly than GDP, with aggregate expenditure increasing at the rate of 3 percent.

Employment is also improving at a rapid rate. Employment is projected to grow 6.5 percent from 2014 to 2024, adding 9.8 million jobs to the U.S. economy, according to a report by the Labor Department on Dec. 8.

The unemployment rate has also fallen sharply this year, from 5.7 percent in January to 5 percent in October, holding at that same level in November, according to the report by the Labor Department on Dec. 4.

 “An initial rate increase would reflect the Committee’s judgment, based on a range of indicators, that the economy would continue to grow at a pace sufficient to generate further labor market improvement and a return of inflation to 2 percent,” Yellen said.

In her strongest hint so far that a rate hike is imminent, Yellen warned, in her speech, of the dangers of further delay.

“Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession,” Yellen said.

Economists have expressed concern about the effect of the rate hike on emerging markets, fearing an outflow of funds back to the U.S. after the rate increase.

“The fact is, we just don’t know what the effect will be,” commented Attila Yesilada, an economist with Global Source Partners in Istanbul in an interview with Anadolu Agency on Tuesday.

It is possible that markets have priced in the rate hike, Yesilada said, but it is also possible that some emerging market currencies will fall sharply against the U.S. dollar. 

The Turkish lira has fallen to about 2.96 against the dollar this week, but that is partly because of troublesome economic news from South Africa which has affected all emerging markets.

But the Brazilian real, which has lost 31 percent in value against the dollar this year, is expected to drop from about  3.81 per dollar on Wednesday morning to below 4 to the U.S. currency if the rate hike is made as expected.

 

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