United States: Fed drops “patient” from guidance, but first rate hike still depends on economic developments
March 19, 2015
At its 17–18 March policy meeting, the Fed’s Open Market Committee (FOMC) made a small modification to its guidance that reinforces the notion that a hike in the federal funds target rate is forthcoming. The Fed removed the phrase “patient” from its statement as expected, but also explained that the decision to begin raising rates is still data dependent and will happen on a meeting-by-meeting basis. Concerns over weak inflation and the impact of global developments on growth, as well as lower median rate projections, suggest that the first rate hike will come later in the second half of the year and that the rate of subsequent hikes will be less aggressive than previously expected. The Fed has been avoiding a fixed timeline as it believes the low interest rates are providing important support for the economy and because it wants to be able to respond flexibly to any changes in the economic scenario.
The Fed’s accompanying statement gave a slightly less upbeat assessment of the economy compared to last meeting. According to the Fed, the pace of economic growth has moderated somewhat in the past two months. There have been further gains in the labor market, household spending is on the rise due to increased purchasing power resulting from low energy prices, and business investment is advancing. However, the Fed did point out that export growth has taken a hit, presumably because of the dollar’s growing strength against other currencies. Committee members also downgraded their growth forecasts. GDP is now expected to increase between 2.3% and 2.7% in both 2015 and 2016, which is down from the 2.6%-3.0% and 2.5%.3.0% projections made in December.
In terms of prices developments, monetary authorities explained that inflation has, “declined further below the Committee’s longer-run objective,” due in large part to declining energy prices. Market-based measured of inflation are low, survey-based measures of longer-term inflation expectations remain stable and the effects of lower energy prices are projected to be transitory. Nonetheless, there seems to be doubt about the path inflation will follow going forward. In fact, committee members lowered their inflation forecast for this year from a range of 1.0%-1.6% in December to 0.6%-0.8% in January.
In order to avoid a loss of momentum in the economy and stoke inflationary pressures, the FOMC confirmed that the federal funds target rate would remain within the current range of between 0.00% and 0.25%. The Fed emphasized once again that decisions to hike the rate still depend on the assessment of a, “wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.” The Committee stated that it will not raise rates until there have been further improvements in the labor market and until it is “reasonably confident that inflation will move back to its 2.0% objective.”
The Fed essentially ruled out a rate hike at its next meeting in April. Moreover, given its lower growth and inflation projections, it is likely to hold again in June, with a first move coming perhaps at the following gathering in September. Fifteen of 17 committee members believe that it will be appropriate to make a rate policy change sometime this year. However, the median projection made by committee members in a supplementary document released after the meeting is for rates to reach 0.625% by the end of 2015, which is down significantly from the 1.125% median projection made in December. The median projection is for rates to reach 1.875% by the end of 2016, which is below the 2.5% median projection from December. This suggests that the pace of rate hikes after take-off will be slower than expected.
Author: Carl Kelly, Economist