Fed hikes interest rates, slows future tightening path

 Fed hikes interest rates, slows future tightening path

By Ann Saphir and Howard Schneider

WASHINGTON (Reuters) - The U.S. Federal Reserve raised interest rates on Wednesday and said it was keeping the core of its plan to tighten monetary policy intact even as central bank officials said they would likely slow the pace of further rate increases next year.

After weeks of market volatility and calls by President Donald Trump to stop increasing borrowing costs, the Fed lifted rates by a quarter of a percentage point. Fed Chairman Jerome Powell also said the central bank would continue drawing down the size of its balance sheet by $50 billion each month.

The rate increase, the fourth of the year, was expected, but Powell's comments on the balance sheet in a news conference, though a repetition of longstanding Fed policy, prompted a sell-off on equity markets.

The S&P 500 index <.SPX> was down about 1.6 percent in late afternoon trading. Bond prices rallied and the dollar <.DXY>, weaker on the day before the decision, regained some ground against most major currencies.

By diminishing its bond market holdings each month, the Fed puts further upward pressure on interest rates, something Trump explicitly requested them this week to stop.

"I think the run-off of the balance sheet has been smooth and has served its purpose, and I don't see us changing that," Powell told reporters after the Fed raised its federal funds rate to a range of between 2.25 percent to 2.50 percent.

The central bank did bow to rising uncertainty about global economic growth, and expectations the U.S. economy will slow next year, with fresh economic forecasts showing officials at the median now see only two more rate hikes next year compared to the three projected in September.

It noted that "some" further gradual rate hikes would be needed, a subtle change that suggested it was preparing to stop raising borrowing costs.

But another message was clear in the policy statement issued after the Fed's last meeting of the year and Powell's comments: The U.S. economy continues to perform well and no longer needs the Fed's support either through lower-than-normal interest rates or by maintaining of a massive balance sheet.

In its statement, the Fed said risks to the economy were "roughly balanced" but that it would "continue to monitor global economic and financial developments and assess their implications for the economic outlook."

The decision to raise borrowing costs again is likely to anger Trump, who has repeatedly attacked the central bank's tightening this year as damaging to the economy.

The Fed has been raising rates to reduce the boost that monetary policy gives to the economy, which is growing faster than what central bank policymakers view as a sustainable rate.

There are worries, however, that the economy could enter choppy waters next year as the fiscal boost from the Trump administration's spending and $1.5 trillion tax cut package fades and the global economy slows.

The Fed also made a widely expected technical adjustment, raising the rate it pays on banks' excess reserves by just 20 basis points to give it better control over the policy rate and keep it within the targeted range.

"I think that markets were looking for more in terms of the pause," said Jamie Cox, managing partner at Harris Financial Group in Richmond, Virginia.

"It's not as dovish as expected, but I do believe the Fed will ultimately back off even further as we move into the new year."

ECONOMIC PROJECTIONS

Fresh economic forecasts released on Wednesday showed policymakers expect two rate hikes next year and one the following year, with the median forecast for the federal funds rate at 3.1 percent at the end of 2020 and 2021.

That would still leave borrowing costs just above policymakers' downgraded view of a 2.8 percent neutral rate that neither brakes nor boosts a healthy economy.

The last set of economic forecasts, released in September, had indicated three rate hikes next year and one in 2020. The change reflects an erosion in confidence in an economic outlook that Powell as recently as October had painted as quite rosy.

Even so, the Fed is still plotting a more aggressive rate hike path than many in the markets expect. Before the meeting, traders of U.S. interest-rate futures were betting the Fed would deliver no more than one rate hike next year, if even that.

Gross domestic product is forecast to grow 2.3 percent next year and 2.0 percent in 2020, slightly weaker than the Fed anticipated in September.

The unemployment rate, currently at a 49-year low of 3.7 percent, is expected to fall to 3.5 percent next year, unchanged from the prior forecast. It is seen rising to 3.6 percent in 2020 and to 3.8 percent in 2021, slightly higher than previously forecast.

Inflation, which hit the Fed's 2 percent target this year, is expected to be 1.9 percent next year, slightly lower than the 2.0 percent forecast three months ago.

There were no dissents in the Fed's policy decision.

(Reporting by Ann Saphir and Howard Schneider; Additional reporting by Lewis Krauskopf in New York; Editing by Paul Simao and Dan Burns)

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Updated Date: Dec 20, 2018 03:05:28 IST