Fed Raises Key Rate, Unveils Plan to Reduce Bond Holdings

June 14, 2017 5:37 pm Last Updated: June 14, 2017 10:38 pm

WASHINGTON—The U.S. Federal Reserve raised its key interest rate for the third time in six months, providing its latest vote of confidence in a slow-growing but durable economy. The Fed also announced plans to start gradually paring its bond holdings later this year, which could cause long-term rates to rise.

The increase in the Fed’s short-term rate by a quarter-point to a still-low range of 1 percent to 1.25 percent could lead to higher borrowing costs for consumers and businesses and slightly better returns for savers. The Fed foresees one additional rate hike this year, but gave no hint of when that might occur.

The overarching message the Fed sent on June 14 was an upbeat one: It believes the U.S. economy is on firm footing as it enters its ninth year of recovery from the financial crisis, with little risk of a recession. Though the economy is growing only sluggishly and inflation remains chronically below the Fed’s 2 percent target, it foresees improvement in both measures over time.

The announcement that the Fed plans to begin paring its balance sheet later this year— “provided that the economy evolves broadly as anticipated” —involves its enormous portfolio of Treasury and mortgage bonds. The Fed began buying the bonds after the financial crisis to try to depress long-term interest rates. That effort resulted in a five-fold increase in its portfolio to $4.5 trillion.

The Fed said it would eventually allow a small amount of bonds to mature without being replaced—an amount that would gradually rise as markets adjusted to the process. This process could put upward pressure on long-term borrowing rates.

The Fed would start with monthly reductions in Treasury holdings of no more than $6 billion and $4 billion in mortgage bonds. Those figures would rise in increments over a year until they reached $30 billion a month in Treasurys and $20 billion in mortgage bonds.

The Fed kept its forecast for economic growth this year of 2.2 percent, up slightly from its March forecast, with growth of 2.1 percent in 2018 and 1.9 percent in 2019. Those forecasts are far below the 3 percent annual growth the Trump administration has said it can achieve through tax cuts, deregulation, and tougher enforcement of trade rules to protect American jobs.