The U.S. Federal Reserve’s Federal Open Market Committee raised interest rates again Wednesday. It's a sign that the Fed believes the economy is in no danger of slowing down, including taking into consideration this week's latest economic reports.
Committee members voted overwhelmingly to raise the target range for the federal funds rate to 1.25% to 1.5%, an increase of .25 of a percentage point. This is the fifth increase since the central bank cut the rate to near zero in 2008, during the height of the Great Recession.
The federal funds rate is the interest rate at which banks and credit unions lend reserve balances to other depository institutions overnight, which affects the interest rates financial institutions charge their customers for loans.
In wrapping up a two-day meeting, the FOMC said since it met in November there were indications the labor market has continued to strengthen and that economic activity has been rising at a solid rate.
“Averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further,” the FOMC said in a statement. “Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters."
It noted that on a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below its target of 2%. However, the committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong.
The FOMC said it expects to increase the federal funds rate three times in 2018, taking it to a little more than 2%. Further hikes expected in 2019 would raise it to around 2.75% and in 2020 to just above 3%. This is close to being on track with earlier announced plans.
The move by the central bank follows numbers released earlier by the Commerce Department that showed the U.S. economy expanded a little more than 3% annually in the third and second quarters of 2017, the first back-to-back performances above this levels since 2014.
Economic reports released this week showed prices at both the retail and wholesale level moved higher in November.
Both the Consumer Price Index (CPI) and the Producer Price Index (PPI) gained 0.4% compared to October.
Increases in energy prices accounted for about two-thirds of the rise in the CPI, with gasoline rising 7.3%% from October. The cost of shelter rose but the price of food was unchanged. All this led to the CPI posting a 2.2% gain over the past year. The annual gain for the PPI was larger, 3.1%, the biggest since January 2012.
The absence of significant inflation pressures has been a puzzle, noted RBC Economics Research.
“Indications such as a low unemployment rate are indicative of the economy operating close to capacity,” said Paul Ferley, assistant chief economist at RBC. “Operating at capacity is usually associated with inflation pressures starting to build, with businesses having increased difficulty responding to rising demand because of resource constraints and thus temper demand by raising prices."
The report provided some confirmation of retailers responding in this expected manner, with services prices up 2.6% over the past year. However, Ferley said, that is being offset by lower goods prices.
“Our expectation is that the growing capacity constraints will increasingly see the price performance of the former dominate, with core inflation resuming an upward trend,” he said.
This observation, coupled with analysis of the PPI report by Wells Fargo Securities that showed both overall and so-called “core producer prices” are posting healthy gains, raises concerns about price inflation over the long term.
While higher inflation would likely be welcome by the Fed, which has a target of it being at 2% annually, there is always the danger prices could overheat, derailing what is expected by the Fed to be an economy that’s expected to increase by 2.5% for all of 2018, slightly better than the current long-run rate of 2.2% annually.