Yes, the U.S. economy is stronger compared with its slump earlier this year. But the Federal Reserve said Wednesday it wants to see further jobs gains and higher inflation before it lifts interest rates from record lows.
The Fed gave no timetable but said it expects the economy’s gains to accelerate later this year. Economic projections released in conjunction with the Federal Open Market Committee meeting corroborate this expectation, which is shared by analysts who say the current growth track will force a hike in the Fed’s key short-term rate in September. That rate’s been held near zero since 2008.
Prab Sagoo, Associate Director at Nasdaq who examines Canadian markets agrees the Fed has opened the door to a September rate hike.
Overall, he says, global markets have been nervous in anticipation of today’s decision. “Coupled with a potential Greek default, it could result in a notable pull back by the broader markets,” Sagoo notes. “Though this might result in purchasing on the dips as some investors continue to find pockets of opportunity out there.”
A statement issued after the Fed’s latest policy meeting noted that the job market, the housing industry and consumer spending are all improving. The Fed’s assessment contrasts with its previous statement in April, when it noted that the economy weakened during winter.
Among economists, the Fed is seen as wanting to prepare investors for a coming rate hike — if the economy continues to improve — while stressing the reassuring message that it will raise rates very gradually.
The idea is to avoid spooking investors, who are already on edge over the likelihood of a rate hike and the threat of a default by Greece’s government. The Fed wants to convince the markets that the economy will be sturdy enough to withstand slightly higher rates.
When the Fed last met in April, the economy had just emerged from a stall-out. Growth in the January-March quarter had been depressed by weather that kept consumers home, a labour dispute that disrupted West Coast ports, a stronger dollar that slowed exports and cheaper oil that triggered cutbacks by drilling companies. After its meeting, the Fed gave no indication it was any closer to raising rates.
Recent economic reports have turned more buoyant, with a rebound in home construction and retail sales and near-record auto sales.
Perhaps most important, the job market has revived, having added an average of 217,000 jobs a month this year. The unemployment rate, at 5.5%, is down from 6.3% a year ago and 7.5% two years ago. Even pay growth, which has languished during the economic recovery, has begun to pick up.
All that points to solid economic growth of around 2.5% in the current April-June quarter.
Yet there are still lingering problems. Though average hourly earnings rose 2.3% in May from a year ago, wage increases remain generally sluggish.
Other labour market indicators — from the number of people jobless for more than six months to the number of part-time workers who would prefer full-time jobs — remain at levels the Fed views as subpar.
Beyond employment, the central bank has yet to achieve its other mandate — promoting stable prices. Inflation has remained persistently below the Fed’s 2% annual target. Too-low inflation tends to hold back economic growth.
Some economists also note that if a Greek default and an exit from the euro currency alliance were to ignite turmoil in global markets, or if investors dumped bonds and sent long-term rates soaring, the Fed might decide to put off a rate increase until next year.
The International Monetary Fund this month downgraded its forecast for the U.S. economy and urged the Fed to consider delaying a rate hike until 2016. IMF Managing Director Christine Lagarde said the risks of raising rates too soon — and slowing and perhaps wounding the economy before it’s reached full strength — outweighed the risks of waiting a bit too long and allowing inflation to creep up.