It would have been bigger news if the Federal Reserve did not increase interest rates. Almost a decade after US policy-makers last hiked rates, the introduction of a 0.25 per cent rise to 0.50 per cent was all but priced-in by financial markets.
Fed chairman Janet Yellen came close to an increase in October but did not ultimately bite. Robust job creation figures released since then bolstered the case for a rise by indicating that the US is coming close to full employment.
The symbolic dimension is important. Long after the crash of 2007-2008, the Fed is keen to start a return to normality in monetary policy. That will still be a good while coming. However, the decision to raise the federal funds target rate marks an inflection point at which the rate cycle turns. Whether this proves to be a turning point in the sweep of financial history is another matter.
US interest rates remain pretty close to rock-bottom levels, and there is no suggestion at this point of a particularly rapid ascent. In advance of the Fed decision, discussion in markets centred on whether two further increases are in prospect for 2016. As recently as September, Fed officials had pointed to the possibility of four rate hikes next year.
Moreover, the Fed’s supersized balance sheet stands at $4.5 trillion (€4.18 trillion). After three rounds of quantitative easing, the global financial system is still flooded with its money. Reining in the balance sheet will take time too.
By moving tentatively to raise rates now, however, the Fed wants to avert the danger that it could be forced into abrupt, large rate increases in the event that the growing American economy finally spurs inflation. The next moves will be crucial. It is clear that the Fed must keep close watch on the impact of this initial move on the economy, the dollar and financial markets.
The significance of the latter is underscored by junk bond jitters as investors weighed the prospect of over-indebted borrowers coming unstuck as rates rise. That comes on top of concerns among some policymakers that world economy is in too feeble a state to justify the Fed’s departure.
Still, this rise doesn’t really count as “lift-off”. Gradualism is the word.
What does it mean in the Irish perspective? The upward trajectory in the US at a time when the main euro zone rate remains as close to zero as makes no difference is likely bring the dollar higher, adding further weight to downward pressure on the euro as the European Central Bank continues its own QE campaign.
This should be good for Irish exports, delivering a bigger return to multinational and indigenous firms from goods they sell outside the euro zone. It should also boost Irish tourism as it would be cheaper for Americans to holiday here. For Irish people travelling outside euro area however, the cost would be higher.
There is fundamental lesson too. Even if an increase in euro zone rates is still years away, the Fed’s decision demonstrates that the cycle will turn eventually .
