Fed Stands Pat, but Says Case for Rate Increase Has Strengthened


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Fed Says Case for Rate Increase Has Strengthened

WASHINGTON—The Federal Reserve left short-term interest rates unchanged Wednesday but signaled it still expected to raise them before year-end, reaching a temporary truce among officials divided over when to withdraw financial stimulus from the economy.

Fed Chairwoman Janet Yellen offered an upbeat assessment of the economic outlook, noting that growth has picked up after a dismal first half, with household incomes growing solidly and workers rejoining the labor force in search of jobs after years of not looking.

Still, she is in no hurry to raise rates to cool the economy because inflation remains below the Fed's 2% target and a growing pool of available labor is preventing wage pressures from building.

"We judged that the case for an increase had strengthened but decided for the time being to wait for continued progress toward our objectives," she said at her press conference following the Fed's two-day policy meeting.

Officials also pared down their estimates for long-run economic growth as well as for the path of interest rates. Policy makers now anticipate only one increase this year, two next year and three in 2018 and 2019. In June, by contrast, they expected two rate increases in 2016, three in 2017 and three more in 2018. Officials now expect long-term growth to settle at 1.8% a year, down from 2% in June.

Ms. Yellen said those changes were a recognition that productivity growth "is likely to remain low for an extended time."

Tapering the path of interest-rate moves is a sign of "resignation" that there will likely not be a major surge in growth in the near future, said Scott Anderson, chief economist at Bank of the West.

"We're most likely to see a continuation of the same modest growth and not a lot of inflation pressures that would prompt a more aggressive rate path," he said.

Investors greeted the Fed decision to hold a steady course warmly. The Dow Jones Industrial Average rose 163.74 points, or 0.9%, to 18293.70. Bond prices rose, driving down the yield on 10-year Treasury notes 0.019 percentage point to 1.668%.

The Fed's stance underscored the lack of urgency the U.S. central bank's leadership feels about lifting rates. The Fed pushed short-term interest rates down to near zero in 2008, nudged them up a quarter percentage point late last year and hasn't touched them since.

The decision also showed the challenge Ms. Yellen faces trying to balance divergent views inside the Fed about how to proceed.

Three regional bank presidents—Kansas City's Esther George, Cleveland's Loretta Mester and Boston's Eric Rosengren— said they dissented because they wanted to raise rates. That marks a rare level of disagreement under Ms. Yellen's leadership; the last time three officials dissented in a rate decision was in December 2014.

Forecasts released by the Fed on Wednesday showed 10 of 17 Fed officials expected to raise the central bank's benchmark federal-funds interest rate—an overnight interbank lending rate—by a quarter percentage point by December, to a range between 0.5% and 0.75%. Three didn't see the need for a rate increase at all this year. Four wanted more than one rate increase, reflecting the broader divisions inside the central bank about how to proceed.

"Most participants do expect that one increase in the federal funds rate will be appropriate this year," Ms. Yellen said, seeking to emphasize the common ground in the room. "I would expect to see that if we continue on the current course of labor-market improvement and there are no major new risks that develop, and we simply stay on the current course."

Fed officials had grown concerned earlier in the year about a range of global problems, including Britain's decision to exit from the European Union and China's uncertain economic outlook. In its postmeeting policy statement on Wednesday, the Fed said risks had become "roughly balanced," meaning the economy has just as good a chance of exceeding the Fed's growth estimates as of falling short.

That risk assessment is often a clue about whether the Fed expects to move rates in the months ahead. When officials see risks that worry them, they aren't inclined to move rates up.

Ms. Yellen noted that the unemployment rate has held steady at or near 4.9% since the beginning of the year even though employers have added about 180,000 jobs a month this year. That means potential workers are coming off the sidelines and preventing the labor market from overheating.

"We found the economy has a bit more running room," Ms. Yellen said.

The Fed's next policy meeting, Nov. 1-2, is a week before the presidential election, and action is unlikely then, leaving a mid-December policy meeting as the Fed's last scheduled chance this year to push rates higher. Traders in future markets place a 59% probability on a rate increase at the December meeting.

Almost 74% of economists surveyed by The Wall Street Journal earlier this month said the Fed's next interest-rate increase would come in December.

"The committee is obviously becoming impatient with the continued buying of time," Roberto Perli, an analyst with Cornerstone Macro, a research firm, said in a note to clients. "Even if Yellen wanted to hold rates back, the committee might not let her."

The Fed's broader message Wednesday was that it was doubling down on its promise to lift borrowing costs very gradually.

At the same time, several Fed officials have lowered expectations for how high they might raise rates over time because of fundamental changes in the global economy.

Aging populations, slower productivity growth and the rise of wealthier emerging markets looking to invest their savings have triggered broad shifts. As a result, officials believe the natural interest rate—the inflation- adjusted interest rate at which inflation and employment stabilize—will remain lower than it has been in the past. Economic growth and inflation likewise would grow more slowly.

That means the Fed can take its time raising rates over the next few years. It also gives officials less room to cut them in a financial crisis or another economic downturn.

Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and David Harrison at david.harrison@wsj.com

  (END) Dow Jones Newswires
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