Yellen threads needle on first rate hike

Federal Reserve Chairwoman Janet Yellen testifies at a hearing on the Semiannual Monetary Policy Report to Congress, July 15, 2014 in Washington.
Federal Reserve Chairwoman Janet Yellen testifies at a hearing on the Semiannual Monetary Policy Report to Congress, July 15, 2014 in Washington. MCT

The Federal Reserve is on schedule to begin raising interest rates by mid-2015, Chair Janet Yellen confirmed Wednesday, sticking to language nonetheless that ensured the central bank will keep its benchmark lending rate at an unusually low level for a considerable amount of time.

The Fed in October ended its controversial program to purchase government and mortgage bonds in support of economic activity. Economists hoped Yellen Wednesday would give clear guidance on when the Fed will begin raising rates that haven’t budged since December 2008, but they did not get it.

Yellen said members of the rate-setting Federal Open Market Committee would study conditions over “at least the next couple of meetings” before making the call to raise the fed funds rate, which influences the cost of lending across the economy. Most mainstream economists still expect that to happen in June if not earlier.

In an unusual move, three of the FOMC participants opposed Wednesday’s statement. Two of them_ Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser_ felt the economy was strong enough to either begin raising rates or at least lose reference to low rates for a “considerable” time frame. Minnesota Fed President Narayana Kocherlakota opposed the statement language because he worried the current low inflation poses a threat to the Fed’s credibility.

“There is a wide range of opinions on the committee. I think its appropriate for people to be able to express their views,” said Yellen, adding that the FOMC is taking “consequential” actions and that was reflected dissent those who wanted to move faster and slower.

The low current benchmark rate of 0 to .25 percent, where it’s been since late 2008, is designed to keep borrowing costs low for big-ticket items such as mortgages, car loans and student loans. The asset purchases too were designed to make riskier investments more attractive and spur activity. Once the Fed begins to raise rates it will do so in ratcheted steps over a period of years, and that will gradually increase the cost of borrowing across the economy.

FOMC participants Wednesday released revised economic projections for 2015 that included the likely path of monetary policy. Nine members saw the fed funds rate above 1 percent next year, meaning at least three rate hikes if the Fed chooses a measured approach. But eight members saw it below 1 percent. Most participants saw that rate above 3 percent by the end of 2016, meaning the prime rate, which banks charge their most creditworthy borrowers, would be over 6 percent.

The projections also reflected a more upbeat of the economy, seeing an unemployment rate between 5.2 percent and 5.3 percent in 2015. That’s versus 5.4 percent and 5.6% projected in September. Participants also expect the economy to grow at an annualized rate of 2.3 percent to 2.4 percent this year, up from 2 percent to 2.2 percent projected in September. Expectations for 2015 growth were unchanged, in a range between 2.6 percent and 3 percent.

That’s a strong number after several disappointing years, and the FOMC statement made clear a stronger job market is part of that.

“On balance, a range of labor market indicators suggest that underutilization of labor resources continues to finish,” the statement noted. “Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.”

The Fed has a dual mission to keep prices stable and full employment. The labor market is improving steadily, but inflation remains at the low end of the Fed’s target range between 1 percent and 2 percent. In fact, the 17 participants on the FOMC project inflation to rise next year at a rate between 1 percent and 1.6 percent. In September, members thought inflation would run between 1.6 percent and 1.9 percent, at the hot end of the Fed’s target.

Falling energy prices had something to do with that, as the price of crude oil is half of what it was last summer, and has brought price drops not only at the fuel pump for consumers but for petroleum products more generally, including fertilizers and plastics.

Inflation is the rise in prices across the economy, and too much of it means the economy is overheating. Too little of it, however, isn’t wanted either because it causes consumers and businesses to sit on the sidelines awaiting even lower prices. That creates a negative spiral that slows the economy.

In her news conference, Yellen noted that falling energy prices “will likely hold down overall inflation in the near term” but a rate lower than the Fed’s 2 percent target is likely to be transitory, she said, noting that “developments in this area bear close watching.”