No Fed Rate Hike; Global Weakness Cited

Central bank leaves open possibility of hike this year.

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Reviewed by: Howard Schneider
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Edited by: Howard Schneider

(REUTERS) – The U.S. Federal Reserve kept interest rates unchanged today in a nod to concerns about a weak world economy, but left open the possibility of a modest policy tightening later this year.

In what amounted to a tactical retreat, the U.S. central bank said an array of global risks and other factors had convinced it to delay what would have been the first rate hike in nearly a decade.

"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," the Fed said in its policy statement following the end of a two-day meeting. It added the risks to the U.S. economy remained nearly balanced but that it was "monitoring developments abroad."

Rate Hike Bias Remains
However, the central bank maintained its bias toward a rate hike sometime this year, while lowering its long-term outlook for the economy. Fresh economic projections showed 13 of 17 Fed policymakers foresee raising rates at least once in 2015, down from 15 at the last meeting in June. Four policymakers now believe rates should not be raised until at least 2016, compared with two who felt that way in June.

The Fed has policy meetings in October and December.

In deciding when to hike rates, the Fed repeated that it wanted to see "some further improvement in the labor market," and be "reasonably confident" that inflation will increase.

The dollar was marked lower against the euro and the yen, falling 1 percent against the European currency. Stocks initially edged higher before turning lower in choppy trade, while the three-year Treasury yield hit a one-week low.

Secular Stagnation
Taken as a whole, the latest Fed projections of slower GDP growth, low unemployment and still-low inflation suggest that concerns of a so-called secular stagnation may be taking root among Fed policymakers. One policymaker even suggested a negative federal funds rate.

The median projection of the 17 policymakers showed the Fed expects the economy to grow 2.1 percent this year, slightly faster than previously thought. However, its forecasts for GDP growth in 2016 and 2017 were downgraded.

Policymakers also forecast inflation to creep only slowly toward the Fed's 2 percent target, even as unemployment dips lower than previously expected. They now expect the unemployment rate to hit 4.8 percent next year, remaining at that level for as long as three years.

The Fed's projected path of interest rates shifted downward, with the long-run federal funds rate now seen at 3.5 percent, compared with 3.75 percent at the last policy meeting.

“The Fed has become more dovish, with growth projections revised down amid rumblings of ‘secular stagnation.’ But there’s a clear signal that, in the absence of any serious derailing of the economy, rates will rise before the year is out," said Chris Williamson of financial information services Markit.