Washington - The US Federal Reserve is raising the interest rate on emergency loans to banks, in a surprise move seen as the start of an exit strategy for radical measures to jolt the economy from recession.
After two consecutive quarters of positive US economic growth, the Federal Reserve Board said on Thursday it was hiking the discount rate, or the primary credit rate, to 0.75% from 0.5%.
Primary credit is provided by the central bank as a backup source of funds to banks.
In a statement, the Fed said its action was part of changes to terms of its so-called discount window lending programmes "in light of continued improvement in financial market conditions."
With immediate effect, the maximum maturity period for primary credit loans was also shortened from 90 days to overnight.
The Fed made clear the changes "do not signal any change in the outlook for the economy or for monetary policy."
But the market read it differently.
The dollar shot up across the board against other major currencies after the announcement, made after the stock market closed. The euro slumped to a nine-month low of $1.3535 in late New York trading.
Raising funds rate
"The most important takeaway is that the Fed is beginning to implement an exit strategy, which is more than what many of the other central banks are doing and therefore this action will be extremely positive for the dollar," said Kathy Lien, director of currency research at Global Forex Trading.
"Although the Fed went out of their way to say that this does not equate to a change in their monetary policy outlook, action speaks louder than words," she said, adding that the move "indicates how hawkish they must be and how serious they are about tightening monetary policy."
Investors saw the action as possibly signalling "the Fed is closer to eventually raising the Fed funds rate," the benchmark interest rate, said Samarjit Shankar, an analyst with The Bank of New York Mellon.
At the last meeting of its policy-making body on January 26-27, the Fed left unchanged its target range for the key federal funds rate - the rate at which the banks charge each other for overnight loans - at zero to 0.25%.
Raising the discount rate itself "does not mean that the Fed is ready to hike rates or has a set time for such a move but it does mean that the Fed is preparing the way," said Robert Brusca, chief economist at FAO Economics.
"With this move, we should expect a lot more speculation on the part of market participants about when the Fed will be willing to move its actual policy rates for the first time."
'Real tightening is still way off'
The Fed slashed the benchmark rate to virtually zero percent in late 2008 in an unprecedented move to induce growth to the world's largest economy as it reeled from a financial crisis stemming from a home mortgage meltdown.
Other analysts predicted an increase in the benchmark interest rate was still far away.
"A real tightening is still a long way off the distance, in our view, given the continued rapid contraction in credit and the sputtering nature of the recovery outside the manufacturing sector," said Ian Shepherdson, chief US economist at High Frequency Economics.
Ryan Sweet, a senior economist with Moody's Economy.com, agreed.
The hike in the discount rate "does not alter our forecast for the central bank to leave both the interest paid on reserves and the fed funds rate target unchanged until the fourth quarter of 2010," he said.
Bank borrowings from the discount window have totaled less than $20bn since mid-November and are 87% below their previous peak, Sweet said, expecting further increases in the discount rate as the central bank moves to normalise policy.
By hiking the discount rate and not the Fed funds rate, the central bank has in essence widened the spread.
The gap between the discount rate and the fed funds target is typically 100 basis points. It is now 50 basis points.
- AFP