Fed sets stage for 2016 rate rise

Posted on September 21, 2016

A heavily divided Federal Reserve left short-term interest rates unchanged but said the case for a rate increase “has strengthened”, in a strong signal that a move is likely before the end of the year.

Three out of 10 of the US central bank’s rate-setters voted against the decision, and called for an immediate increase. But the Fed said that for the time being it wanted to keep policy on hold as it waits for further evidence of progress towards its objectives, leaving the target range for the federal funds rate at 0.25 per cent to 0.5 per cent.

    The three dissenters who voted for a quarter-point rise in the meeting were Esther George of the Kansas City Fed, Loretta Mester of the Cleveland Fed, and Eric Rosengren of the Boston Fed.

    The opposition was a notable departure given previous efforts by Janet Yellen, the ­Fed chair, to keep dissent to a minimum, underscoring the intensity of the policy debate at the US central bank.

    “The committee judges that the case for an increase in the federal funds rate has strengthened, but decided, for the time being, to wait for further evidence of continued progress toward its objectives,” the Federal Open Market Committee said. It added that the risks to the outlook were “roughly balanced” — a further signal that a move could come by the end of 2016.

    US stocks climbed modestly further into the black, while Treasuries were little changed, and the US dollar fluctuated, as investors digested remarks from the Fed indicating the case for a rate rise had “strengthened”.

    Speaking in a press conference, Ms Yellen said the committee was “generally pleased with how the US economy is doing”. But she said it had decided to keep rates unchanged because there was scope for further improvement in the labour market and inflation was continuing to run below the Fed’s 2 per cent target.

    The Fed was not seeing suggestions of “overheating”, Ms Yellen added. “The economy has a little more room to run than might have previously been thought. That is good news.”

    The Fed has been blowing hot and cold on the prospects of a second rate move this year after being stung by rocky financial market movements after its December increase. Overseas hazards have tended to be the cause of delay, among them uncertainties over Chinese foreign exchange policies and the UK’s vote to leave the EU.

    The decision came hours after the Bank of Japan announced an overhauled monetary easing strategy as it seeks ways of further stimulating its economy. The BoJ set a cap on 10-year bond yields and vowed to overshoot its 2 per cent inflation target as it seeks to escape from its low-inflation rut.

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    The Fed’s decision was particularly highly charged given the political context. The US faces a highly consequential presidential election in less than two months, and Donald Trump, the Republican candidate, has repeatedly attacked the Fed for keeping rates low, claiming this was at the behest of President Barack Obama.

    Asked about Mr Trump’s comments on the Fed, Mrs Yellen responded by saying “emphatically” that partisan politics does not play a role in the Fed’s policy decisions, adding that transcripts of its recent meetings would bear that out when they are released in five years. “We do not discuss politics at our meetings and we do not take politics into account in our decisions,” she said.

    Earlier this year the Fed was vocal about the hazards associated with the UK referendum on its EU membership. However Ms Yellen studiously avoided making any suggestion that US political risk was having an impact Fed monetary policy now. The reason for keeping rates low this week was because the economy was not overheating and there was scope to let the jobs market recovery run its course, she said.

    She insisted the Fed’s meeting in November, just days before the November 8 election, would be a “live” one at which the FOMC could make policy changes. And she insisted she had not seen evidence that corporate investment was being damped by US election uncertainty. “I am not going to get into politics,” she said.

    The Fed’s final meeting of 2016 is on December 13-14.

    The decision to hold rates marks another chapter in the most glacial rate-raising cycle in recent times, underscoring the disappointing economic recovery since the financial crash.

    Fed forecasts in December 2015 pointed to four increases this year. The outcome has been very different. The median of Fed forecasts on Wednesday pointed to just one increase this year, with the year-end prediction for the target range centred on 0.625 per cent.

    Three policymakers saw no rate increase this year.

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    Economic data going into the meeting have been on the soft side, although by no means weak enough to derail the case made by several policymakers for tightening.

    Payroll growth in August was shy of expectations, for example, as were retail sales. On the other hand, consumer price inflation numbers firmed last week. The Fed’s statement implied that the economy is getting closer to full employment, as it stated that labour market conditions will strengthen “somewhat” further.

    On the other hand, the Fed’s statement noted that measures of inflation compensation have remained low, something that has concerned some policymakers who want to see strong evidence that inflation is on track to hit the 2 per cent target.

    The Fed’s new interest rate projection for 2017 left rates centred at 1.125 per cent, down from 1.625 per cent in June. The median forecast was at 1.875 per cent in 2018 and 2.625 per cent for 2019.

    Forecasts have changed in part because the Fed has reassessed its view of the economy’s longer term outlook and formed the judgment that rates will need to be lower to keep growth on an even keel.

    The economic outlook is now seen as weaker than in the Fed’s last set of predictions in June. Growth this year is now expected to be 1.8 per cent, rather than 2 per cent as predicted in June, and the longer-run growth rate was also trimmed to 1.8 per cent. Core inflation is tipped to hit 2 per cent in 2018, after running at 1.7 per cent this year and 1.8 per cent in 2017.

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