Federal Reserve raises key interest rate, signaling economic confidence

Last Updated Dec 13, 2017 6:14 PM EST

The Federal Reserve is raising a key interest rate for the third time this year, signaling continued confidence in a U.S. economy that's moving into its ninth year of expansion. 

The target federal funds rate — what banks charge each other for loans — has been raised to the range of 1.25 to 1.5 percent, or a hike of one-quarter of a percentage point. It's the fifth rate increase during Federal Reserve Chair Janet Yellen's tenure. Yellen is stepping down in January, to be replaced by Jerome Powell. 

The Federal Reserve Open Markets Committee, the central bank's rate-setting body, factored in the expected effects of the tax cut package that is in its final stages in Congress. 

"We have seen a significant increase in the stock market, and at least some portion of that likely reflected expected tax changes," Yellen told reporters on Wednesday. While saying it would be "very difficult" to achieve the 4 percent growth President Donald Trump has promised, she touted strong consumer spending and confidence as factors that would keep the economy growing at a "moderate" pace in future years. The Fed expects GDP to grow at 2.5 percent next year, slowing down to 2 percent in 2020. 

Asked about the recent run-up in bitcoin prices, Yellen largely demurred, saying the Fed does not have a role in overseeing so-called cryptocurrencies.

"[Bitcoin] is not a stable store of value and it does not constitute legal tender," she said. "It is a highly speculative asset."

Nonetheless, the Fed is studying the possibility of creating its own digital currency, she later said. "While we're looking at research on this topic, there are, to my mind, limited benefits to introducing it, a limited need for it and substantial concerns," Yellen said.

The Federal Open Markets Committee, the Fed's rate-setting body, said in a statement that it expected that "economic activity will expand at a moderate pace and labor market conditions will remain strong." Two members of the committee, however, had voted to keep rates steady: Charles Evans, president of the Federal Reserve Bank of Chicago, and Neel Kashkari, president of the Federal Reserve Bank of Minneapolis.

Markets had anticipated the increase given the overall strength of the economy. The unemployment rate has slipped to a 17-year low of 4.1 percent, although wages haven't been rising much and inflation still lags the Fed's target. 

"For a number of years now, inflation has been running under 2 percent. I consider it a priority that inflation doesn't undershoot its objective," Yellen said. However, most of the committee members believe that the rate is held down by temporary factors, she said.

She also pushed back on notions that stocks were overvalued, saying economists "are not great at knowing what appropriate valuations are."   

"The fact that those valuations are high doesn't mean they are necessarily overvalued. We are in a low-interest-rate environment… that's a factor that support higher valuations," she said. Indeed, if the Fed keeps interest rates low, as it seems likely to for the near future, those prices will likely persist. 

"If you're in an environment where growth can continue, then corporations can continue to generate additional earnings and justify those prices," said Jim Barnes, director of fixed income at Bryn Mawr Trust.

Some economists are skeptical, calling the Fed's prediction of low unemployment and modest growth Pollyannish. "This looks hopelessly unrealistic to us," Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in a note. "[T]he Fed forecasts an endless expansion, with minimal inflation pressure, despite unemployment well below their Nairu estimate - unchanged at 4.6% - forever and interest rates peaking at 3.1%. We wish Jay Powell the best of luck; he's going to need it."

The Associated Press contributed reporting.