Why the Fed raised US rates and what it's likely to mean

Markets Associated Press

Well, finally: To the surprise of almost no one, Federal Reserve policymakers decided Wednesday to raise short-term U.S. interest rates for the first time in a year.

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Before the announcement, investors had pegged the chances of a rate hike Wednesday at 92.9 percent, according to the CME Group.

The stock market viewed the news as anticlimactic and barely budged.

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WHAT DID THE FED DO?

The Fed increased its benchmark interest rate — the so-called fed funds rate — to range of 0.50 percent to 0.75 percent from 0.25 percent to 0.50 percent. The rate is still extraordinarily low. During the financial crisis, the Fed slashed the rate to near zero and kept there for seven years. By lowering borrowing costs, the Fed hoped to encourage consumers and businesses to spend and bust the economy out of the deepest recession since the 1930s. Economists say the low rates helped revive the economy — though the recovery has been lackluster by historical standards.

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On Dec. 16, 2015, Fed policymakers raised the rate for the first time since 2006. The central bank was expected to follow up with perhaps four more rate hikes this year. But it held off until Wednesday, worried about weakness in the global economy and slow growth in the United States.

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WHY DID THE FED DECIDE TO RAISE RATES?

The Fed said Wednesday that the American job market looks strong and the overall economy is "expanding at a moderate pace." The unemployment rate fell in November to a nine-year low 4.6 percent. And the economy expanded from July through September at a 3.2 percent annual pace, fastest in two years. The Fed expects inflation to edge up and closer to its 2 percent annual target.

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WHAT WILL THE RATE HIKE MEAN FOR CONSUMERS AND SAVERS?

Not much, experts say. The Fed doesn't directly affect rates on auto and student loans. But credit cards, home-equity loans and adjustable-rate mortgages are based on benchmarks such as the banks' prime rate, which moves in lockstep with the fed funds rate, and could rise soon, though likely not by much.

Long-term mortgage rates are already climbing but not because of the Fed. Investors have driven mortgage and other long-term rates higher because they expect President-elect Donald Trump's plans to slash taxes and increase infrastructure spending will lead to faster economic growth and higher inflation.

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WILL THE HIKE HAVE BROADER ECONOMIC IMPLICATIONS?

Economists don't expect the higher borrowing costs to do much harm to steady but unspectacular U.S. economic growth. But higher U.S. rates are likely to draw investors away from the rock-bottom rates in Europe and Japan. Turning to U.S. investments, they are likely to drive up the value of the dollar, which is already near a 14-year high. A dearer dollar makes U.S. products costlier in foreign markets and hurts American exporters. A higher dollar will also squeeze foreign companies that borrowed in U.S. dollars; to make loan payments, they will need to exchange more of their cheaper local currency into American dollars.

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WHAT HAPPENS NEXT?

Fed policymakers expect to raise rates three times next year. They see the fed funds rate at 1.25 to 1.5 percent by the end of 2017; 2 percent to 2.25 by the end of 2018 and 2.75 percent to 3 percent by the end of 2019.