What's So Important About the Federal Reserve's Interest Rate?

Washington: On Wednesday the Federal Reserve, the US central bank, is expected to raise its federal funds interest rate for the first time in nearly 10 years. Here are the things to know:

1. Why is the Fed funds rate important?

The rate, which applies to overnight loans between banks, sets the basis for short-term lending in the financial sector. Combined with expectations for future rate moves, it also guides longer-term interest rates which affect how much people pay on loans to buy homes and cars, how much businesses pay on their borrowings, and how much banks pay for deposits. It also has a big impact on what foreign companies and governments pay to borrow. 

2. Why is this week's decision so important? 

The Fed has kept the rate locked next to zero -- officially 0-0.25 per cent -- since December 2008, having slashed it to counter the impact of the financial crisis and the economy's plunge into recession. It has remained so low because the economy has taken a long time to recover. By raising the rate, likely just a tick to 0.25-0.50 per cent, the Fed will be signaling that the economy can now grow firmly under a more "normal" or tighter monetary policy.

3. What impact will a rate increase have?

Since the Fed has been flagging an imminent rate rise for much of this year, the increase itself should not have much impact. Interest rates have already tightened, and the US dollar has strengthened, in expectation. Stock investors have had time to prepare. What is important is what the Fed indicates about future rate increases. If the Fed's economic forecasts on Wednesday point to relatively rapid increases, the dollar could rise further and loan and deposit rates could also move higher. Meanwhile other currencies, particularly in emerging markets, could fall, hurting those with significant dollar debt and dollar-based costs.

4. Is a rate increase certain?

Nothing is certain, but a Wall Street Journal survey of economists showed 97 per cent expect it. If the Fed holds off, it would come as a shock and raise worries about the state of the US economy.