The US Federal Reserve (Fed) on Wednesday decided to raise benchmark interest rate by 25 basis points, the first interest rate increase since 2006 and marking the end of an era of extraordinary easing monetary policy.

“Given the economic outlook, and recognising the time it takes for policy actions to affect future economic outcomes, the [Federal Open Market] Committee decided to raise the target range for the federal funds rate to between 0.25% and 0.5%,” the Fed said in a statement after concluding its two-day policy meeting on Wednesday.

The central bank held that there had been considerable improvement in labour market conditions this year, and it was reasonably confident that inflation would rise to its 2% target over the medium-term.

“This action marks the end of an extraordinary seven-year period, during which the Federal Reserve funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression,” Fed chairperson Janet Yellen said at a press conference on Wednesday.

CONFIDENCE IN ECONOMIC OUTLOOK
With gradual adjustments in the stance of monetary policy, the US economy would continue to expand at a moderate pace and the labour market would continue to strengthen, said the central bank in the statement.

Fed officials also saw the risks to outlook for both economic activity and the labour market as balanced.

“Although developments abroad still pose risks to US economic growth, these risks appear to have lessened since last summer,” said Yellen.

According to a projection report released on Wednesday, Fed officials expected the US economy would grow 2.4% in 2016, slightly higher than their September forecast of 2.3%.

The unemployment rate would further fall to 4.7% in 2016, lower than their September forecast of 4.8%.

“The US economy has exhibited enough strength over the past year, and the unemployment rate has fallen far enough that raising rates by 25 basis points will not derail the US expansion,” said Former Fed economist and senior fellow at the Peterson Institute for International Economics (PIIE) David Stockton.

Responding to concerns surrounding the raising of the interest rate in a persistently low inflation environment, Yellen explained that transitory factors that were holding down inflation, such as low oil prices and a strong dollar, were expected to abate over time, while diminishing slack in labour and product markets should put upward pressure on inflation as well.

As it took time for monetary policy actions to affect future economic outcomes, it was appropriate for the Fed to take action now to avoid overheating the economy and overshooting the inflation target, according to Yellen.

GRADUAL RATE HIKES AHEAD
In light of the current shortfall of inflation from the central bank’s 2% target, the Fed expected that the developments of economic conditions would warrant “only gradual” increases in the benchmark interest rate, according to the statement.

The core personal consumption expenditure price index, the Fed’s favoured inflation gauge, increased only 1.3% year-on-year in October.

The future increases in interest rate would be data dependent and the central bank would not follow any mechanical formula in the path of rate hikes, said Yellen.

According to the projection report, Fed officials expected the federal funds rate to reach 1.4% in 2016, 2.4% in 2017, and 3.3% in 2018, compared with their September forecast of 1.4% in 2016, 2.6% in 2017, and 3.4% in 2018.

This implied that the central bank would likely increase interest rate by 25 basis points for four times next year, but the pace for rate hikes in 2017 and 2018 would be slower than their September forecasts.

“With inflation remaining so low, the Fed will need to be cautious about further removal of monetary accommodation,” said Stockton. He said that the Fed should not be on any fixed path of a series of rate hike, but must be attentive to the incoming data on inflation and must monitor the effects of their actions on the strength of economic activity.

FED DOWNPLAYS IMPACT ON EMERGING ECONOMIES
At the press conference, Yellen downplayed the negative spillover impact on emerging market economies. Although there could be negative spillovers through capital flows, there were also positive spillovers on to the emerging market economies, as the rate hike took place in the context of a strong US economy, she said.

According to the central bank chief, many emerging markets were in the stronger position than they would have been in the 1990s. Emerging market economies had stronger macroeconomic policies, and had taken steps to strengthen their financial systems, said Yellen.

“I do not see Fed policy as posing significant risks to the Chinese economy at this point,” Stockton told Xinhua. Fed tightening could add fuel to capital outflows from China, but the country has sufficient reserves to offset the effects of the capital outflows, said Stockton.

PIIE senior fellow Nicholas Lardy also held the similar view. He said “the impact of Fed’s move on Chinese economy is quite modest.”

According to Lardy, capital outflow was only a moderate issue to China, as the reduction in the official holding of US dollar-denominated assets might reflect the fact that Chinese corporates were repaying their dollar-denominated loans back to commercial banks.

“Dollars (assets) are now in commercial banks rather than in the central bank, and the money has not gone out of China,” said Lardy.

According to the expert, China had a great deal of autonomy in managing its macro-policies, and the performance of the Chinese economy depended to considerably extend on what happened to the housing market.

If housing investment continued to slow down in 2016, China’s economic growth would slow further to 6.5% next year. On the other hand, if the housing market was on the verge of recovery, as some people believed, the economy would probably grow around 7%, according to Lardy.