Fed OKs First Rate Hike In 4 Years

Encouraged by the U.S. economic recovery, the Federal Reserve boosted its overnight interest rate target from 1 percent to 1.25 percent on Wednesday, the first increase in four years.

The quarter-percentage-point increase in the federal funds rate will likely be only the first of many rate hikes over the coming months as the central bank returns interest rates to a neutral level.

The vote was unanimous.

"With underlying inflation still expected to be relatively low, the committee believes that policy accommodation can be removed at a pace that is likely to be measured," the Fed said in a statement.

The Fed said it would respond to changes in the economy as needed. The committee said the risks on inflation and growth were balanced.

The Fed expressed no sense of urgency over rising inflation.

"Although incoming inflation data are somewhat elevated, a portion of the increase in recent months appears to have been due to transitory factors."

In a separate vote, the Fed raised the discount rate by a quarter point to 2.25 percent.

The question for borrowers, lenders and central bankers alike is how fast rates will rise.

To answer that question, analysts will sift through the wording of the Fed statement, the speeches given by Fed officials over the next few weeks, and most importantly, the upcoming economic data on jobs, output and prices.

The rate increase was widely anticipated by markets and analysts. It will likely be followed immediately by banks and other lenders raising their own interest rates to customers, raising the costs of borrowing and braking the pace of economic growth.

Many market interest rates adjusted in advance of the Fed's move. Mortgage interest rates, for instance, have risen by a full percentage point since the lows seen last summer.

The Fed had signaled an increase at its meeting in May, saying it anticipated that extra stimulus to the economy could be removed at a "measured pace."

The Fed retained the "measured pace" language in its statement following the two-day meeting that concluded Wednesday. However, the central bank added that it would "respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."

The Fed dropped interest rates 13 times beginning in January 2001 in a bid to cushion the economy from a severe collapse in business investment, the shock of the 9/11 terror attacks and the small chance that price stability would be threatened by deflation. See a history of the FOMC's moves.

In the summer of 2003, the fed funds rate sank to 1 percent, a 46-year low. The Fed held rates at 1 percent through the fall and winter despite the fastest economic growth in 20 years, as core inflation rates continued to fall and job growth remained tepid.

During the spring, however, job growth accelerated and prices jumped higher, forcing the Fed's hand.

The federal funds rate is the rate banks charge each other for overnight loans to meet the Fed's reserve requirements. The Fed influences the funds rate by adding or draining liquidity from the economy through open market purchases or sales of Treasury notes.