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Fed raises rates and plans another two hikes this year to see off inflation threat

Tim Wallace
Interest rates are going up – the Federal Reserve, headed by Jerome Powell, now expects to raise rates four times this year - AP

US interest rates are set to rise further and faster than previously planned as surging economic growth forces officials to do more to try to see off the threat of inflation.

The Federal Reserve raised interest rates for the second time this year, taking the range of its Federal Funds Rate from 1.75pc to 2pc, up by 0.25 percentage points.

Officials now expect four rate rises this year, not three as the balance of policymakers has shifted since March.

The ‘dot plot’ chart which shows when rate-setters expect to tighten monetary policy shows two policymakers think the Fed has already hiked enough. Five believe one more hike is needed in 2018; seven want two more hikes; and one wants three.

The median official anticipates a further three rate rises in 2019, with interest rates ending up at a maximum of 3.5pc by the end of 2020.

"The economy is doing very well. Most people who want to find jobs are finding them. Unemployment and inflation are low," said Fed chair Jerome Powell.

"Returning interest rates to a more normal level as the economy strengthens is the best way for the Fed to create an environment in which businesses and households can thrive."

He said stronger household confidence and incomes have pushed up consumer spending, while tax cuts and government spending are boosting the economy, as is surging business investment.

This contrasts with the Bank of England and European Central Bank which have both struggled to move away from emergency low interest rates from the financial crisis. European economies face the possibility of slowing growth which will make it harder still to return to more normal rates.

The Fed edged its 2018 GDP growth forecast up to 2.8pc, from 2.7pc in March, while there was no change to its 2019 or 2020 outlook which are expected to be 2.4pc and 2pc respectively.

Unemployment should fall to 3.6pc this year – below an earlier forecast of 3.8pc – and 3.5pc next year.

Inflation will rise to 2.1pc this year and stay there, compared with earlier forecasts that inflation would not reach this level until 2020.

As this is above the Fed’s 2pc inflation target, it requires higher interest rates.

“The better-than-expected employment report for May marked the 92nd straight month of payrolls growth – the longest stretch in the history of the data,” said Kully Samra at Charles Schwab.

“Inflation is still subdued, but there remains the risk that the Fed could end up behind the curve and having to tighten more quickly if inflation accelerates more sharply.”

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Rising price pressures could represent the biggest threat to world economic growth, economists at ratings agency Fitch believe.

Fitch also expects unemployment to reach a 66-year low of 3.4pc next year.

As a result its analysts expect this to lead to higher wages with indicators suggesting “it is only a matter of time before sharper upward pressures on US wage growth start to be seen”.

Sharper interest rate rises could be the result.

"An inflation shock in the US could bring forward adjustments in US and global bond yields and sharply increase volatility, harming risk appetite,” said Fitch’s chief economist Brian Coulton.

“In particular, it could lead to a rapid decompression of the term premium, which remains negative for US 10-year bond yields. In combination with a likely aggressive Fed response, this would be disruptive for global growth.”