Key points

• The U.S. Federal Reserve has increased its benchmark interest rate by 25 basis points to a target range of 3.75% to 4.0%. This is the first increase in three years. 
• Elevated inflation was cited as the reason for the increase. 
• We see the Bank of Canada remaining on hold this year, but risks of an earlier rate hike have increased given stubbornly high inflation. 

Two weeks ago, the Bank of Canada announced that it was leaving its trend-setting policy interest rate where it has been since December at 2.25%.

The U.S. Federal Reserve had also been on the sidelines since December, leaving its target range for the federal funds rate at 3.50% to 3.75%. That changed today, with the announcement of a 25-basis point increase, raising the target range to 3.75% to 4.0%. Members of the Federal Open Market Committee (FOMC) voted 12-0 in favour of the hike.

Because short-term interest rates (like credit cards and car loans) move with the Fed's decisions, the increase means that borrowing costs just got higher in the U.S.

With that said, because long-term bond yields have been rising as the market has expressed concern that the Fed has been too optimistic about inflation’s return to target, today’s hike may ease some of this concern and help ease the pressure on longer-term rates.

Why the increase?

The Fed has a dual mandate: keep prices stable and maximize employment. Like the Bank of Canada, the Fed prefers inflation to average 2%. With the headline inflation rate in the U.S. averaging 3.3% so far this year (Jan-Aug), price growth—even if largely driven by “temporarily high” energy prices—was getting too hot for it to stay on pause.

Earlier indications by Fed Chair Warsh that he would support a hike if inflation was not coming down also meant that his credibility was at stake if no action was taken.

According to the statement, “today's policy action will support a timelier return to the Committee's 2 percent [inflation] goal.”

Warsh noted at the press conference that the "labor side of the Fed's congressional remit is in good shape,” but that “inflation is too high and has been for too long.”

Where rates go from here is still uncertain. What is clear, though, is that the Fed is not likely to be cutting anytime soon. According to the "dot plot" of FOMC members, the median member of the panel projects one more 25-basis-point rate hike this year. The FOMC meets again in October and December.

In Canada, inflation is also running above the 2% target and could stay that way if energy prices remain elevated, but is not as high as it is in the U.S. At the same time, Canada’s economic growth is weaker than it is in the U.S., making a rate increase potentially more harmful.

Hence, we expect the Bank will remain in a ‘wait and see’ hold at the October meeting. Our base case is that they hold this year and raise by 50 basis points next year. However, we now see an increased risk that the Bank moves earlier, both reflecting more hawkish language from the Bank and resurging energy prices.

Answer to the previous trivia question: The United States won the 2026 FIBA Women's Basketball World Cup, defeating France 97 to 79.

Today’s trivia question: When did Kevin Warsh become the Chair of the U.S. Federal Reserve?