Fed Keeps Rates Unchanged, Sees Only Two Hikes This Year

The Federal Reserve has reached a virtual consensus to raise interest rates twice during the remainder of the year as the U.S. economy continues to muster strong job growth despite global weakness.

Fresh policy and economic projections from Fed officials on Wednesday showed a clear majority expect two quarter-point hikes by the end of 2016, absent a major shock to the economy or job market, while 12 of seventeen expect either two or three hikes.

In keeping its key overnight interest rate unchanged in the current range of 0.25 percent to 0.50 percent, the Fed balanced what it described as "strong job gains" against the fact that "global economic and financial developments continue to pose risks."

But the clustering of opinion among Fed policymakers, which represented a sharp narrowing of rate projections since the last round of forecasts in December, shows a balance emerging between the need to recognise that continued U.S. economic strength warrants higher rates with a desire to stick with a go-slow approach given the uncertainties of the global economy.

It is a situation not without inconsistency: the Fed’s official policy statement said inflation had ticked up, policymakers' individual inflation forecasts ticked down, and Fed Chair Janet Yellen told reporters she was not sure what the data indicated.

Headline inflation has been rising, but "I am wary and have not yet concluded that we have seen a significant uptick that will be lasting," Yellen said at a press conference following the Fed's two-day policy meeting.

Yellen also said the U.S. economy had proved "very resilient in the face of shocks," but noted that global risks were still too apparent to hike rates at this time. She said that "caution" would provide more certainty the U.S. economic recovery would be sustained.

The half-empty half-full approach avoids any clear resolution of a disagreement at the highest levels of the central bank over how to interpret recent data. Yellen indicated as much, noting that the policy-setting committee had for the second meeting in a row been unable to agree on summary language about the overall risks faced by the U.S. economy.

A risk assessment has been a staple of Fed statements, used as a way to signal the direction of policy.

"We decline to make a collective assessment," Yellen said. "Some participants see them as balanced. Some see them as weighted to the downside."

She stressed the uncertainty facing the committee, with its members poised to hike rates even as they cut the U.S. growth forecast and slowed the expected pace of monetary tightening.

Overall, "you have seen a shift in most participants' path of policy. That largely reflects a somewhat slower projected path for global growth," Yellen said. Interest rates will move higher if the Fed's baseline forecast proves accurate, she added, "but proceeding cautiously will allow us to verify" that the economic recovery remains on track.

CAUTIOUS APPROACH
In its policy statement, the Fed noted the risks still emanating from overseas, which Yellen said included renewed signs of weakness in Japan and Europe, and the ongoing slowdown in China.

"Our first take on this is that it probably leans slightly more dovish, relative to expectations," said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.

The dollar fell sharply against a basket of currencies after the statement. Yields on U.S. Treasuries dropped across the board, while stock markets rallied. The S&P 500 closed at its highest level since Dec. 31.

In fresh individual forecasts, policymakers projected weaker economic growth and lower inflation this year and lowered their estimate of where the targeted lending rate would be in the long run to 3.30 percent from 3.50 percent - a signal that the economic recovery would remain tepid.

The interest rate outlook was a shift from the four quarter-point hikes expected when the Fed raised rates in December for the first time in nearly a decade. But global market volatility early this year clouded that plan.

The Fed had adopted a cautious approach at its last policy meeting in January, amid a selloff on financial markets, weaker oil prices and falling inflation expectations.

Policymakers also signalled on Wednesday they expected continued improvement in the job market, with the unemployment rate expected to decline to 4.7 percent by the end of the year and fall further in 2017 and 2018.

And they marked down their forecast for inflation this year to 1.2 percent from 1.6 percent, though it's seen recovering to close to the central bank's 2 percent medium-term target next year.

Kansas City Fed President Esther George dissented in favour of raising rates at this week's meeting.

(Reuters)