WASHINGTON - The United States Federal Reserve raised interest rates for the first time in nearly a decade, signalling renewed confidence in the US economy.
Fed chairman Janet Yellen in the news conference on Wednesday (Dec 16) said: "We see an economy that is on a path of sustainable improvement."
The new target for the federal funds rate - the amount banks charge to lend to each other overnight -- is 1/4 to 1/2 per cent, up from the zero to 1/4 per cent range.
This long-anticipated announcement was made on Wednesday after a two-day policy meeting among the central bank's top officials.
The Fed statement said: "There has been considerable improvement in labour market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 per cent objective."
"Given the economic outlook, and recognising the time it takes for policy actions to affect future economic outcomes, the committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 per cent."
Ms Yellen also said that if the Fed did not reduce the amount of accommodation now, the economy would "end up overshooting both employment and inflation objectives".
The hike now would thus prevent a situation where the Fed might have to "tighten abruptly", to slow down the economy.
The Fed has not raised rates since 2006. In 2008, it cut the target interest rate to near zero as a way of propping up the economy after the collapse of Lehman Brothers.
An unconventional bond-buying programme, known as quantitative easing, had also been used to pump about US$3.5 trillion (S$4.9 trillion) into the US economy to steer it through the financial crisis. That ended in October last year.
Lower interest rates made funds cheaper, providing incentive for consumers and businesses to borrow money and stimulate the economy.
But stronger economic indicators in recent months have prompted the Fed to believe it is time to tighten monetary policy.
On Tuesday, the Labour Department reported a 0.2 per cent rise in the core Consumer Price Index last month -- the third consecutive month it has increased by that margin.
Unemployment also hit 5 per cent in October and November this year, down from the high of 10 per cent in Oct 2009.
Assistant professor Alessandro Rebucci from the Johns Hopkins Carey Business School said the Fed has been "cautious in pulling the trigger" but there is a need for rates to revert to normal and "the evidence is solid to start the normalisation".
As for the impact on American consumers, associate professor Steven Kyle from the Dyson School of Applied Economics and Management at Cornell University said: "It is not a huge change in terms of credit for consumers, and definitely not for businesses because there is a lot of cash awash in the system."
Banks such as JP Morgan and Wells Fargo were among the first to bump up the prime rates - the rates at which banks lend to favoured customers - from 3.25 per cent to 3.5 per cent.
Both banks, however, did not announce increases in deposit interest rates.
Moving forward, the Fed is expected to increase rates gradually. But Ms Yellen clarified that does not mean the increases would be equally sized or equally spaced out, instead it would be "data dependent".
In terms of the effect overseas, assistant professor Rebucci said the key channel through which other countries would feel the effects is through currency exchange.
As the dollar appreciates against foreign currencies, "foreign economies will be given the opportunity to increase exports to the US".
However, he said the effect could be balanced out on the financial side as emerging markets have a large amount of debt in foreign currency, and with the dollar appreciating and Asian currencies going down, "the difficulty might come in the form of outright financial strain".
Stock markets in the US, however, reacted positively to the news, with the Dow closing 224 points higher and the Standard and Poor's 500 Index up 29 points.