Global markets are braced for the most pivotal moment since the financial crisis, as the Federal Reserve prepares to raise interest rates for the first time in nearly a decade.
The US central bank is expected to increase interest rates from their current 0% to 0.25% range later today, Wednesday, in what UK Chancellor, George Osborne, has called the most anticipated decision “in living memory”.
Despite the change in policy being “priced in”, traders will nonetheless be on edge as Janet Yellen, the Fed’s chairman, outlines plans for future rate hikes.
Larry Summers, the former US Treasury secretary, warned that a move to raise rates would be premature. “There are still substantial questions about the growth prospect, about the prospect of achieving the 2% inflation target, about uncertainties in financial markets,” he told Bloomberg.
Fed policymakers have been hesitant to tighten policy, preferring to wait for signs that inflation was on a path back to the central bank’s 2% target.
The dollar climbed by more than 0.6% against the pound on Tuesday, after inflation data seemed to secure the case for interest rates to rise.
The latest figures showed that one measure of inflation rose by a greater than expected 0.5% in the year to November.
So-called “core inflation”, which strips out more volatile components, climbed to an 18-month high of 2%, from 1.9% in the previous month.
While economic conditions might present a “Goldilocks moment” for the Fed to take its first steps towards higher rates, analysts warned that it may soon have to retrace its steps. Jim Reid, a strategist at Deutsche Bank, said that officials will probably not “get that far… before the cycle eventually turns over”.
“If the next recession comes in the next couple of years, it’s hard to imagine rates being high enough that the Fed will be able to avoid returning to zero again with risks that a fourth round of quantitative easing will be needed,” Mr Reid said.
Anticipation of the shift by the Fed has prompted sharp adjustments in financial markets since the summer, as investors adjust after seven years of close to zero rates. An exit from very stimulatory policy signals the end of a lengthy period of financial repair in the US, as the wounds inflicted by the 2008 crash have taken an unprecedented length of time to heal.
The Fed has repeatedly found its attempts to raise rates thwarted by external factors; firstly by severe falls in commodity prices, which have weighed down on inflation; and latterly by concerns this summer that global growth had faltered in emerging markets.
The interest rate rise is unlikely to be a “one and done” move, but the first in a series of increases that could cause turmoil in emerging markets.
Ms Yellen will be keen to repeat the Fed’s mantra that rises will be limited and “gradual”, stressing that subsequent rate hikes will come at a slower pace than in previous cycles.