Federal Reserve raises interest rate for the first time in nine years (Updated)

Editor’s note: Story updated with press conference comments from Fed Chair Janet Yellen, and with reaction from Arkansas bankers and U.S. Rep. French Hill, R-Little Rock.

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In a move expected from almost every market watcher, the Federal Reserve on Wednesday (Dec. 16) announced a small rate hike from 0.25% to 0.5%. The move ended almost seven years of a near-zero percent rate and was the first rate hike in more than nine years.

Members of the Federal Open Market Committee (FOMC) cited “considerable improvement in labor market conditions” as a primary reason for the change.

“The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation,” noted part of the Fed statement.

YELLEN MEDIA COMMENTS
Fed Chair Janet Yellen said during a press conference that the FOMC also decided to raise the federal fund rates to reflect the monetary policy panel’s confidence that the U.S. economy will continue to strengthen.

“This action marks the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression,” Yellen said. “It also recognizes the considerable progress that has been made to restoring jobs, raising incomes and easing the economic hardship of millions of Americans.”

Yellen told reporters that the U.S. economy, which has seen an average Gross Domestic Product growth of 2.25% over the first three quarters of 2015, has shown dramatic improvement coming out of a long recession.

“The economic recovery has clearly come a long way, although it is not yet complete. Room for further improvement in the labor market remains and inflation continues to run below our longer run objective,” she said. “But with the economy performing well and expected to continue to do so, the committee judged that a modest increase in the federal funds rate is now appropriate, recognizing that even after this increase, monetary policy remains accommodative.”

Yellen also said that looking forward, the process of “normalizing” U.S. interest rates will proceed gradually, and future policy actions will largely depend on how well the economy reaches the committee’s goal of maximum employment and 2% inflation.

“Since March, the committee has stated that it would raise the target range for the federal funds rate when it had seen further improvement in the labor market and is reasonably confident that inflation would move back to its 2% objective over the medium term. In our judgment, these two criteria have now been satisfied,” Yellen said.

ARKANSAS IMPACT
Five economists recently surveyed by Talk Business & Politics before the Fed announcement predicted a rate hike.

Jeff Collins, Talk Business & Politics’ economist and former director of the Center for Business and Economic Research at the University of Arkansas, said perception would play a part in the Fed move.

“I think the Fed will take some modest action and incrementally move interest rates up. It is interesting because the Fed has taken a lot of heat for being too accommodating in regards to monetary policy. There are people who say that ‘easy money’ has created imbalances that can eventually only lead to inflation. From an inflation perspective, there really doesn’t seem to be a lot of obvious inflationary pressure in the economy, but there is definitely the perception that the time has come for the Fed to do something. Long answer to a simple question, I do expect the Fed to raise rates very modestly,” Collins explained.

The impact in Arkansas, according to Collins, may primarily be on short-term consumer debt.

“Closer to home in Arkansas, I think the impact is going to be on consumers who use credit. For example, credit cards are tied to short-term rates, and the long-term rates are the kind of rates where you go to buy a car or a house, or some other large capital (purchase),” he said.

John Shelnutt, director of economic analysis and tax research at the state Department of Finance and Administration, said growing concerns about inflation would push the rate higher.

“I expect a small rate hike by the FOMC with assurances that the Fed will take a ‘wait and watch’ stance in 2016 for any further rate changes based on additional signs of inflation and better than expected rates of economic growth. Their focus is on core inflation and not energy or other traditionally volatile components,” Shelnutt said. “I doubt a small rate change in the near term will have much impact on the real economy, assuming there is stability and momentum to fundamentals of domestic growth.”

ARKANSAS REACTION
U.S. Rep. French Hill, R-Little Rock, and a former banker, used the rate increase to push for a change in how the Fed makes monetary decision policies.

“While the markets have been making these adjustments for months, today the Federal Reserve has begun to raise the federal funds rate after holding it near zero for seven years. While I’m glad to see the Fed take this step, in my view, it needs to develop a more rules-based approach to monetary policy, such as that contained in the House-passed FORM Act, to prevent ambiguity in the future,” Hill noted in a statement.

Mark Roberts, president of Malvern National Bank, said the financial industry has prepared for a rate hike but hopes the Fed doesn’t increase the pace of rate hikes.

“We are excited to see the Federal Reserve take action to raise rates.  We have prepared for an increase in rates for some time now and feel that we are well positioned for a rising rate environment,” Roberts said. “That being said, I would anticipate that any future increases will be small and spaced out allowing the economy time to adjust.  It has been a tough few years for savers and people who are dependent on interest to live. Hopefully, we can maintain a middle ground which will give these folks some relief without a lot of negative impact on borrowers.”

Reynie Rutledge, CEO for Searcy-based First Security Bank and former chairman of the Arkansas Bankers Association, said the Fed’s move is a sign of confidence in the overall U.S. economy.

“With the increase in the federal funds rate today, the Federal Reserve Bank is signaling that our economy is showing signs of sustainable improvement, which is a long-awaited positive indicator of our economic recovery. Along with this move, the Fed has implied it will not automatically increase rates each quarter, but rather weigh results against economic indicators of inflation and unemployment to determine if our economy is truly sustaining the strength necessary to grow,” he said.

“We look forward to seeing steady growth in our economy again and the positive effects on jobs and income in our local communities across Arkansas. Even with the increase in rates today, the cost of financing for most Arkansans to purchase homes and other large items like cars will remain at historic lows for the next few years. We are looking forward to 2016 and stronger growth rates across the board,” Rutledge added.

Bob Fehlman, chief financial officer and Treasurer of Pine Bluff-based Simmons First National Corp., said the Fed in 2016 could push the rate up to 1%. He said the increase could provide a “slight benefit to income” for banks, but the industry will continue to face competitive lending pressures.

“I think the banking industry will see a slight increase in loan rates, but the competitive lending environment will dictate individual loan pricing. It is similar on the deposit side of the balance sheet. I would expect deposit rates to increase slowly over the course of 2016. Most banks still have a lot of liquidity on the balance sheet, thus you wouldn’t expect a quick increase in deposit rates,” Fehlman noted in a statement to Talk Business & Politics. “In reality, this 25 basis point increase will have very little impact. However, the Fed has made their first interest rate increase in 9 years. The unknown is how much and how fast will the Fed increase rates.”