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The Federal Reserve agreed on an interest rate hike on Wednesday, for the second time in three meetings, disregarding recent slumps in inflation and retail sales.

The Fed hiked interest rates by a quarter point to 1.25% in a move that was widely expected by the financial markets. In doing so, the central bank also offered some details about how it intends to shrink its $4.5 trillion balance sheet.

The fed on the future of interest rates in 2017

“Near-term risks to the economic outlook appear roughly balanced, but the committee is monitoring inflation developments closely,” the Federal Open Market Committee (FOMC) said in an official statement Wednesday following a two-day meeting. “The committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.”[1]

In a press conference following the rate announcement, Fed Chair Janet Yellen signaled she is moving ahead with plans to normalize monetary policy despite the recent slowdown in inflation. In her view, price pressures will rise due to stronger labour market conditions.[2]

The Fed announced more than just the rate hike

U.S. consumer prices softened in May for the second time in three months, while a measure of core inflation falling to its lowest level since 2015.[3] The consumer price index (CPI) declined to 1.9% annually in May from 2.2% the previous month, Labor Department data showed Wednesday. Core consumer inflation slipped to 1.7% from 1.9%.

A separate report from the Commerce Department showed an unexpected decline in retail sales, raising red flags about the consumer-driven economy. Receipts at retail sales declined 0.3% last month, confounding expectations for a 0.1% increase.

Markets react to the interest rate hike

Disappointing economic data offset a hawkish Fed to weigh on the U.S. dollar, which finished flat against a basket of world currencies. The dollar index (DXY) closed at 96.94 on Thursday. Its subdued reaction to the FOMC meeting suggests that investors are finding it difficult to justify faster rate hikes in the short term.

In equities, the S&P 500 Index pared losses to finish down 0.1%. The Dow Jones Industrial Average rose 0.2% on route to a new record high.

 

[1] Christopher Condon and Craig Torres (14 June 2017). “Fed Raises Rates, Maintains Forecast for One More Hike.” Bloomberg.

[2] Rich Miller (14 June 2017). “Yellen Doubles Down on Bet Hot Job Market Stokes Inflation.” Bloomberg.

[3] Sam Bourgi (14 June 2017). “S&P 500 Futures Fall From Record Amid Energy Selloff.” Economic Calendar.

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