Federal Reserve leave rates unchanged but see case for increase

A heavily divided Federal Reserve left short-term interest rates unchanged on Wednesday 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 policymakers voted against the decision to hold rates. But the Fed said it wants to keep policy on hold for now 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 voted for an immediate rate rise in the meeting: Esther George of the Kansas City Fed, Loretta Mester of the Cleveland Fed, and Eric Rosengren of the Boston Fed.

The opposition represents a notable departure, given Fed chair Janet Yellen’s previous efforts to keep dissents to a minimum, underscoring the intensity of the current 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.

The committee added that 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 and Treasuries were little changed as investors digested remarks from the Federal Reserve indicating the case for a rate rise had “strengthened”.

Rocky markets

The Fed has blown 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 central bank 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.

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. The Republican candidate, Donald Trump, has repeatedly attacked the Fed for keeping rates low, claiming this was at the behest of President Barack Obama.

The Fed’s next meeting is just days before the November 8th election, making it a difficult moment to change policy. Its final meeting of the year is on December 13th-14th.

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.

Payroll growth slow

Economic data going into the meeting had 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.

Still, the Fed’s statement noted that measures of inflation compensation have remained low, something that has concerned those 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.

– Copyright 2016 The Financial Times Limited