The US Federal Reserve Board?s move on Thursday to increase the primary credit rate?more commonly known as the Fed discount rate?from 0.5% to 0.75% has sparked speculation amongst investors concerning other potential rate changes. The discount rate is one of the measures the Fed used to protect the US economy during the instability of the economic crisis, notably by dropping the rate dramatically so that banks could receive emergency loans from the Fed. Thursday?s hike was the first discount rate increase since June 2006, indicating, according to economists, that the Fed believes the worst of the crisis is over.
The initial reaction to the decision was uncertainty as the move took most Fed-watchers by surprise. Even though Fed chairman Ben Bernanke had taken care to announce the impending increase during his February 10 testimony before Congress, few expected it to happen just eight days later. The hike is designed to encourage banks to borrow more from each other rather than from the Fed, especially as use of the Fed discount window has been rare recently due to the strengthening economy.
While the impact of the discount rate increase is relatively small, the change has prompted speculation regarding whether other Fed actions are on the horizon, such as monetary tightening and, specifically, an increase in the federal funds rate, which affects interest rates for individuals and businesses. This possibility and the element of surprise prompted jittery markets immediately following the announcement. However, the Fed has been careful to offer reassurances that any such moves are still a long way off, especially since the economy remains relatively weak. The recently released US Consumer Price Index and inflation figures for January?both low?confirm that such changes are unlikely.
Still, investors say that the Fed discount rate hike indicates that the era of loose money is beginning to come to an end. After the initial shock of the ?surprise?, US markets have responded well because investors see it as a sign that the economy is getting back on its feet. Given the reaction to this relatively insignificant Fed discount rate increase, future policy modifications by the Fed can be expected to stir up investors even more.
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