The Economy

Fed Ends Seven Years of Zero Interest Rates

The long-anticipated rate hike to 0.25% will be followed by a "gradual" tightening of monetary policy, the central bank emphasizes.
Matthew HellerDecember 16, 2015

As expected, the U.S. Federal Reserve on Wednesday finally ended its zero-rate era, voting to raise interest rates by 0.25% but stressing that further tightening of monetary policy will be “gradual.”

The interest rate hike is the first since 2006, concluding what Fed Chair Janet Yellen called “an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression.”

The central bank cited “considerable improvement in labor market conditions this year” for its long-anticipated decision, also noting that it is “reasonably confident that inflation will rise, over the medium term, to its 2 percent objective.”

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“Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent,” the Fed said in a news release.

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The Washington Post said the rate increase while small is “a vote of confidence that the American economy — dogged by volatile oil prices, a slowdown in China, and weak global growth — will stand resilient.”

But Yellen said the “process of normalizing interest rates is likely to proceed gradually” and “Even after today’s increase, the stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.”

The Fed’s policymaking committee “expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate,” she added. “The federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

“It’s all about the speed at which rates rise and where they settle,” Luke Bartholomew, investment manager at Aberdeen Asset Management, told the Post. “It will be very steady but probably not as steady as markets are expecting.”

The Post noted that the “pace of economic expansion remains significantly slower than it was before the financial crisis. Wage growth has been stagnant, and many unemployed workers have given up hope of ever finding a job.”

In a note on Wednesday afternoon, Moody’s Investors Service said U.S. companies with good credit quality would be able to afford the 0.25% increase in short-term interest rates. However, “credit risk will increase for some weaker companies because refinance risk will rise for them as interest rates edge higher and the debt market becomes increasingly risk averse.”

Lenders and other suppliers of credit “could either decline to extend credit to companies with weak business fundamentals and aggressive capital structures, or only offer such companies credit at prohibitive prices,” said Moody’s.

The interest rate increase will not affect most U.S. companies for another couple of years, “when they begin to refinance a significant balance of debt maturities coming due in 2019-20,” Moody’s said.