Fed Raises Rates for First Time in 2016, Anticipates 3 Increases in 2017

Fed Raises Rates for First Time in 2016, Anticipates 3 Increases in 2017

Central bank will nudge up the federal-funds rate by a quarter percentage point to between 0.50% and 0.75%

By HARRIET TORRY

Updated Dec. 14, 2016 4:08 p.m. ET

WASHINGTON—The Federal Reserve said Wednesday it would raise its benchmark short-term interest rate, and expects to lift it more quickly than previously projected in 2017 amid signs of low unemployment, firming inflation and a pickup in economic growth.

“Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made” and that it is expected to make, Fed Chairwoman Janet Yellen said at a press conference in Washington.

Fed officials said they would nudge up the federal-funds rate by a quarter percentage point on Thursday, to between 0.50% and 0.75%, a move that could cause other household and business borrowing costs to rise as well.

They also indicated they see a brightening economic outlook and expect to raise short-term rates next year by another 0.75 percentage point—likely in three quarter-point moves.

That’s a bit more than the two increases in 2017 the policy makers anticipated in September. The shift reflects their individual views on factors including the unemployment rate, which recently hit a nine-year low, and the prospect of new tax cuts and government spending increases after President-elect Donald Trump takes office, Ms. Yellen said.

The Fed said in a statement after its two-day meeting that the rate increase came “in view of realized and expected labor-market conditions and inflation,” a sign officials see the labor market as close to, or at, full employment—the lowest level unemployment can reach without triggering too much inflation.

The Fed continues to expect “gradual” rate increases, the statement said, although forecasts showed officials see rates rising faster next year than previously thought.

Officials expect the median fed-funds rate to be 1.4% by the end of 2017, according to the projection of 17 officials. According to their forecast, the fed-funds rate would reach 2.1% at the end of 2018 and 2.9% in 2019. That implies three quarter-percentage-point interest-rate increases a year in each of the next three years or nine increases in total. That is a faster pace than officials projected in September, when they only saw two rate increases next year.

The statement’s message centered on a strong labor market and repeated its view that “near-term risks to the economic outlook appear roughly balanced.” The Fed said it continues to closely monitor inflation indicators and global economic and financial developments.

When the Fed moves next will depend on various factors. Mr. Trump’s election victory has boosted market expectations that his administration will cut taxes and increase spending, which could spur growth and inflation. This has pushed major U.S. stock indexes to record highs since Election Day. Such expectations also sent the yield on the 10-year Treasury note above 2.5% for the first time in two years on Monday.

How Fed Rates Move Markets

Fed officials judge the economy has made enough progress to warrant a further step on the path it started a year ago when it began a slow retreat from easy money. They raised the fed-funds rate by a quarter percentage point last December after holding it near zero for seven years during the financial crisis, recession and fitful economic recovery.

The Fed’s decision to raise rates cements the U.S. economy’s status as an outlier among the world’s largest economies. So far this year the European Central Bank, the Bank of England, the Bank of Japan and central banks in Brazil, South Korea and India have all cut rates—some into negative territory—to fuel stronger inflation and growth.

Officials’ projections for the coming years were generally rosier than their last batch in September, on a number of fronts. They expect inflation to rise from 1.5% in 2016 to 1.9% in 2017 and to its target of 2% in 2018. They saw the jobless rate falling to 4.5% next year and remaining there through 2019.

The Fed welcomed recent signs of further improvement in the labor market. The jobless rate fell to 4.6% in November, a nine-year low. “Job gains have been solid in recent months and the unemployment rate has declined,” the Fed said.

Officials predicted the economy would expand at a median annual pace of 1.9% this year and 2.1% in 2017, a slight improvement from September, when officials last submitted forecasts. The shift could reflect a recent stream of better economic data, or the fiscal outlook.

The Fed chairwoman won a unanimous vote. Ms. Yellen had faced dissent at five out of eight meetings this year, a sign of divisions within the Fed over the path of monetary policy.

The central bank began this year expecting to nudge rates up four times in quarter-percentage-point increments. It didn’t move until now because of recurrent worries about growth, weak inflation, hiring and turbulence overseas—concerns that have since dissipated.

The Fed has been telegraphing the rate increase for months. In September, the central bank said the case for an increase had strengthened but found the economy had “a bit more running room,” Ms. Yellen said. In mid-November testimony to Congress, Ms. Yellen said a rate increase was possible “relatively soon” due to the economy’s “very good” progress on job creation and inflation.

Whether other interest rates—such as on savings accounts, mortgages, car loans and corporate loans—rise as well depends on how investors, businesses and households respond.

In the past, Fed rate increases usually rippled through the economy, causing other borrowing costs to rise too. But the market doesn’t always follow the Fed’s lead. Between 2004 and 2006, when the Fed raised its benchmark short-term rate 4.25 percentage points, yields on 10-year U.S. Treasury notes and corporate bonds and mortgage rates barely budged because of strong global appetite for U.S. securities.

Ahead of the Fed’s announcement, John Caldwell, general manager of Galeana’s Van Dyke Dodge in Warren, Mich., said he expects little impact on car sales from a quarter-percentage-point rate rise.

“If our average loan of $25,000 has a term of six years, a quarter-point only adds $190,” he said. “In the big picture it’s very small.”

Signs that the Fed may become more aggressive on raising rates “could put upward pressure on mortgage rates,” said Michael Fratantoni, chief economist at the Mortgage Bankers Association. The December rate increase had been fully priced in by markets ahead of Wednesday’s announcement, he said, but signs of the future path of rates has the impact to shift the market.

Mortgage rates have spiked since the election and hit a 2016 high last week, according to Freddie Mac. A 30-year fixed-rate mortgage averaged 4.13% for the week ending Thursday, compared with 3.95% this time a year ago.

The Fed’s rate increase goes into effect Thursday. The central bank also raised the rate it charges on emergency loans, known as the discount rate, by a quarter percentage point to 1.25%.

The increase in interest rates will come as some relief to savers, who have seen returns on deposits languish at rock-bottom levels for years. Other businesses, such as mortgage brokers, expect higher rates to have a negative impact after years of ultralow borrowing costs.

Low rates have been “very good” for business, according to Eduard Van Loenen, president of First Portland Mortgage Corp. in Portland, Maine.

“We’ve had a nice long ride here, since probably the early 1990s,” he said, adding the refinancing side of his business will suffer due to the rate increase, because fewer people will find it worthwhile to renegotiate their mortgages.

Write to Harriet Torry at harriet.torry@wsj.com

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