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The 25 basis-point hike is the first raise in three years and comes ahead of critical midterm elections in the United States.
The United States Federal Reserve has said it will raise interest rates by a quarter of a percentage point as inflation, driven by soaring fuel prices amid the US-Iran war, continues to weigh on the economy.
The Fed, which is the central bank of the US, said on Wednesday that it will hike interest rates by 25 basis points to 3.75 percent to 4 percent.
It is the first hike in more than three years and comes just weeks before the US midterm elections, despite repeated demands from US President Donald Trump to lower rates.
“Economic activity is expanding at a solid pace. While uncertainty remains elevated owing, in part, to geopolitical developments, domestic spending has been resilient,” the Fed said in a statement on Wednesday.
“Inflation remains elevated. Today’s policy action will support a timelier return to the Committee’s 2 percent goal. The Committee will deliver price stability.”
CME FedWatch, which tracks the likelihood of monetary policy decisions, forecast a 92.3 percent chance of the Fed increasing rates to 3.75 to 4 percent. A week ago, that forecast was a 40 percent chance of a quarter-percent rate increase.
But in the days since, a slew of data shifted those expectations.
For one, consumer prices jumped in August by 0.4 percent, the highest increase in four months. On an annual basis, prices rose 3.4 percent, matching the increase recorded in July, while the job market remains healthy.
Since then, benchmark crude oil prices have continued to soar as strikes in the US-Israel war on Iran have intensified. Brent crude hovered near $109 per barrel on Tuesday.
The average price for a gallon (3.8 litres) of petrol is $4.36, up 14 cents in the past week, and up from $4.06 in the last month, according to the American Automobile Association (AAA), which tracks daily petrol prices.
Diesel, on the other hand, was at $6.31, the highest recorded average and roughly double from a year ago. That, in turn, is expected to further stoke prices as diesel is used in trucks to haul everything from fruits and vegetables to steel and cement.
At the same time, the benchmark 10-year Treasury yield broke above the psychologically important 5 percent threshold on Tuesday, hitting 5.02 percent, its highest level in 19 years. The yield serves as a benchmark for borrowing costs, including car loans and home mortgages, and is a bellwether for inflation.
“The economy is in an unusual place,” Michael Klein, professor of international economic affairs at Tufts University’s Fletcher School and executive editor of EconoFact, a nonpartisan economic and social policy publication, as unemployment remains at a comfortable level while higher prices continue to stick, sending inflation beyond the Fed’s target of 2 percent.
“There [has been] a lot of pressure on Chairman Warsh to raise interest rates because of inflation coming in high, and that has been compounded by concerns about Trump’s pressure” as the president has continued to demand that interest rates be lowered, Klein said.
“Higher interest rates tend to weaken the economy… but if the market believes that there’s going to be a rate increase, it’s priced in already as prices move on news, so this won’t be news,” Klein said, adding that should help steady yields.
