Fed raises rates by 25 bps: What it means for inflation and labour market

Janet Yellen

The Federal Reserve has raised the interest rates at which banks borrow by 25 basis points to 1.12 per cent on Wednesday for the second time in three months, brushing off a recent run of mixed economic data. It forecasted one more hike this year.

The Fed has now raised rates four times as part of a normalisation of monetary policy that began in December 2015. The central bank had pushed rates to near zero in response to the financial crisis.

What reasons did the Federal Reserve cite?

1. The US central bank’s rate-setting committee said the economy had continued to strengthen, job gains remained solid and indicated it viewed a recent softness in inflation as largely transitory.

2. The Fed also gave a first clear outline on its plan to reduce its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession.

3. It expects to begin the normalisation of its balance sheet this year, gradually ramping up the pace. The plan, which would feature halting reinvestments of ever-larger amounts of maturing securities, did not specify the overall size of the reduction.

What is the initial cap?

The initial cap for the reduction of the Fed’s Treasuries holdings would be set at $6 billion per month, increasing by $6 billion increments every three months over a 12-month period until it reached $30 billion per month.

For agency debt and mortgage-backed securities, the cap will be $4 billion per month initially, rising by $4 billion at quarterly intervals over a year until it reached $20 billion per month.

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