The discount rate is the interest rate at which banks short of liquidity can borrow funds from the Fed against collateral. The Fed is evidently increasingly confident about the mor stable condition of the money markets and the US banking system. Otherwise, a hike in the rate for emergency loans would not be warranted. In our view, the Fed’s assessment of the situation is correct.
The financial markets reacted with disappointment to the Fed’s move. However, this negative response is unlikely to last as awareness grows that the strengethening upward trend in the US economy will not be affected by a modest tightening of monetary policy. Although the hike in the discount rate does not signal an immediate rise in the federal funds rate, moderate increases in the key rate are on the cards in the second half of 2010 at the latest.