Federal Reserve announces historic US interest rate hike
17/Dec/2015 • Currency Updates•
The Federal Reserve finally ended an unprecedented seven-year-long period of near zero interest rates and what amounted to emergency settings in monetary policy last night by announcing it would be hiking its benchmark interest rate for the first time since June 2006.
The interest rate was increased by 25 basis points to 0.50% from 0.25%, right in line with our and indeed market expectations. Critically, the decision was a unanimous one, with all members of the committee voting for an immediate rate increase.
While a rate hike was universally anticipated and almost fully priced in, the focus was on the tone of the accompanying statement and indications as to the timing and pace of future interest rate increases in 2016 and beyond.
Policymakers judged that there has been “considerable improvement in the labour market” this year. While inflation remains well below target, there’s “reasonable confidence” that price growth will move higher over time. Headline inflation, however, is expected to remain low for some time, only increasing back up towards its 2% target in 2018.
On the topic of future rate increases, the Federal Open Market Committee sent mixed signals. Its statement suggested that the evolution of economic conditions would likely “warrant only gradual increases” in the future, but the “dot plot” of future hike expectations of FOMC members was unchanged from September.
A median calculation of policymakers’ expectations for next year suggests that the committee still expects to hike roughly once a quarter in 2016, the equivalent of every other meeting. This is right in line with our expectations, although a faster pace than the market is currently pricing in, which at present expects only two additional hikes next year.
This emphasis on gradual rate hikes initially weighed on the US Dollar, although the currency strengthened as the press conference went on, ending 0.7% and 0.6% higher against the Euro and Pound respectively. Currency markets clearly took the decision in their stride, which is not entirely surprising given how strongly flagged last night’s announcement had been.
We continue to believe that gradually increasing interest rates in the US in 2016 should lead to an appreciation of the US Dollar against almost every major currency next year. This appreciation will be particularly severe against the Euro, given the European Central Bank is moving in the opposite direction with its monetary policy, with more gradual gains for the Dollar against Sterling, considering we expect higher rates in the UK at some point in the third quarter of 2016.
Economic releases in the US, and indeed world economy, will be mostly overlooked today, with financial markets likely to be driven almost exclusively by the reaction to yesterday evening’s announcement.
Major currencies in detail:
The lack of any major surprises in the Fed statement last night meant that Sterling ended only marginally lower against the US Dollar, down by 0.6%.
Earlier in the day we saw some very mixed labour data from the Office for National Statistics. Encouragingly, the rate of unemployment in the UK fell again in the three months to October, down unexpectedly by 0.1% to 5.2%, its lowest level in nearly 10 years.
In contrast, and bad news for the hawks among the Bank of England’s monetary policy committee, earnings growth fell more than expected, declining to 2% excluding bonuses from the 2.5% recorded a month previous. This will make it increasingly difficult for the BoE to justify a rate hike in the first half of next year.
The Euro fared slightly worse than the Pound following the Fed announcement, depreciating by 0.7% versus the Greenback.
There was some relatively encouraging inflation data in the Eurozone on Wednesday, providing a very tentative sign that the ECB may have been justified in maintaining its existing level of quantitative easing at its most recent meeting in December.
Consumer prices increased more than originally thought in November, albeit only modestly, accelerating to 0.2% on an annualised basis, its highest level since July. Core consumer price growth remained unrevised at 0.9%.
Earlier in the session, manufacturing growth accelerated to a PMI of 53.1 from 52.8 in October, while the services PMI dipped marginally by 0.3 index points to 53.9.
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