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The Federal Reserve has raised its benchmark interest rate for the second time this year and signalled that it may step up its pace of rate increases because of solid economic growth and rising inflation.

The Fed now foresees four rate hikes this year, up from the three it had previously forecast.

The central bank on Wednesday raised its key short-term rate by a modest quarter-point to a still-low range of 1.75% to 2%. The move reflects the economy’s resilience, the job market’s strength and inflation that’s finally nearing the Fed’s target level.

The action means consumers and businesses will face higher loan rates over time.

Despite the anticipated faster pace of future rate hikes, Royce Mendes, director and senior economist at CIBC, says in emailed commentary that “projections for where rates end up in 2020 and beyond didn’t budge.” That means the peak and expected long-term rates remain the same.

The increased pace suggests Federal Open Market Committee members see the economy “chewing through whatever slack remains a little faster given the boost from fiscal stimulus, but that government spending and tax cuts have done little to alter structural trends which pose a headwind to rates longer term,” says Mendes.

Still, the Fed’s statement and projections together signal a more hawkish stance from policymakers in the near term, says Mendes. “As a result, the U.S. dollar has gained ground, and yields have increased,” he adds.

More details on U.S. monetary policy

It was the Fed’s seventh rate increase since it began tightening credit in 2015, and it followed an increase in March this year.

When the Fed last met in May, it left its short-term rate unchanged. But it noted that inflation was edging near its 2% target after years of remaining undesirably low. Should inflation eventually pick up, the Fed might move to tighten credit more aggressively.

A gradual rise in inflation is coinciding with newfound economic strength. After years in which the economy expanded at roughly a tepid 2% annually, growth could top 3% this year. Consumer and business spending is powering the economy, in part a result of the tax cut President Donald Trump pushed through Congress late last year.

With employers hiring at a solid pace month after month, unemployment has reached 3.8%. Not since 1969 has the jobless rate been lower.

Beginning in 2008 in the midst of the financial crisis, the Fed kept its key rate unchanged at a record low near zero for seven years. It then raised rates once in 2015, once in 2016, three times in 2017 and now twice this year.

The Fed aims to achieve its mandates of maximizing employment and stabilizing prices by lowering rates to spur growth during times of economic weakness, and raising rates to slow growth if the economy threatens to overheat. When the Fed tightens credit, it aims to do so without derailing the economy. But if it miscalculates and overdoes the credit tightening, it can trigger a recession.

The economic expansion has survived for nine years and is now the second-longest in history. It will become the longest if it lasts past June 2019, at which point it would surpass the expansion that lasted from March 1991 to March 2001.

Read: Tilting away from cyclicals: Are we there yet?

While many economists think the current expansion will exceed the 1990’s streak, some worry about what might occur once the impact of the tax cuts begin to fade and the Fed’s gradual rate hikes begin to curb growth.

Diane Swonk, chief economist at Grant Thornton, has suggested that the economy could experience a “growth recession,” in which the gross domestic product slows so much that unemployment starts to rise.

Read: Recession a possibility by end of 2020: U.S. biz economists

The Fed’s pace of rate hikes for the rest of the year could end up reflecting a tug of war between a sturdy economy and the risks to growth, including from a potential trade war that could break out between the United States and such key trading partners as China, the European Union, Canada and Mexico. All those countries have vowed to retaliate against any U.S. tariffs with their own penalties against U.S. goods.

A global trade war would risk cutting into U.S. economic growth by depressing American export sales and raising inflation by making consumers and businesses pay more for imports.

Read: Why a bad NAFTA deal is better than no deal at all

The Fed’s meeting this week is to be followed by policy meetings of two other major central banks—the European Central Bank on Thursday and the Bank of Japan on Friday. While Japan’s central bank isn’t expected to make any major policy shifts, anticipation is rising that the ECB may outline as early as this week plans to begin paring its bond-buying stimulus program as a prelude to ending them altogether.

Also read:

How inflation data weigh on central banks

Originally published on Advisor.ca
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