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Fed Hikes Key Interest Rate by 0.25 Percent

  • Ken Bredemeier

The U.S. central bank Wednesday boosted its benchmark interest rate for the first time in nearly a decade, a decision that immediately increased borrowing costs for American businesses and consumers, and could ripple through the world economy.

After months of deliberation, Federal Reserve policy makers increased the key interest rate for short-term borrowing for the most credit-worthy U.S. institutions by a quarter of a percentage point, pushing it up from near zero where it has been for seven years.

Within minutes, major U.S. banks increased their prime lending rates to key business customers, which will affect homeowners who borrow against the value of their residences.

Federal Reserve chair Janet Yellen said policy makers decided to increase the rate as the U.S. economy expands "at a moderate pace." She said there has been a "solid expansion of domestic spending" in the U.S., where consumer purchases account for about 70 percent of the world's largest economy.

She said the U.S. economy, even when economies across the globe are weaker, is showing "considerable strength."

The Fed said it could continue to boost the rate in 2016. But it said the pace of more increases would be "gradual" as the central bank continues to monitor U.S. economic conditions, especially whether the very low annual inflation rate in the country -- 0.4 percent - advances closer to the two percent rate it considers to be optimal.

Stock markets react

The rate boost was not a surprise. Economic analysts have been predicting for several weeks the Fed would act as the U.S. economy grows at a modest, if not robust, pace. The U.S. economy, adding 200,000 jobs a month, is advancing even as the second biggest economy in China slows and Europe's 19-nation euro currency bloc lags with tepid growth. The Fed predicted a 2.4 percent advance in the U.S. economy next year.

World stock indexes gained ground Wednesday in advance of the Fed decision, with stocks closing sharply higher across Asian markets, and increasing more modestly in Europe. After the Fed's announcement, U.S. stock indexes quickly jumped to 1 percent gains for the day, an apparent sign that investors were unworried about the higher borrowing costs corporations will now incur.

The Fed's interest rate hike affects the rate the country's most credit-worthy institutions pay when they borrow and lend overnight funds held by the Fed to each other. But the rate change could also affect financial transactions across the globe because of the influence of the Fed on other central banks.

The Fed had kept the interest rate as low as possible to boost lending and economic activity in the United States as it recovered from the depths of the steep recession in 2008 and 2009 that was the worst in the country since the Great Depression of the 1930's, costing millions of people their jobs and homes.

But now the U.S. jobless rate is at its historically typical five percent, even as many part-time workers are still looking for full-time jobs or better positions more attuned to their skills. Yellen said the current jobless rate could fall even further next year, perhaps to 4.7 percent.

The rate boost could be the first of several if the U.S. economy continues to improve. Yellen and other policy makers say a "gradual" series of rate hikes could be imposed in the coming months to keep the economy from expanding too rapidly and hold inflation in check, but policy makers could also hold off if U.S. economic growth slows.

The Fed said that if U.S. economic fortunes continue to advance, it could mean quarter-point rate increases every three months or so over the next three years that could lead to a 3.25 percent benchmark rate by the end of 2018.

In Europe, the eurozone's central bank is continuing its large-scale purchase of bonds to boost the continent's economy and cut unemployment. The Federal Reserve also used such a stimulative measure, but ended it more than a year ago.