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Fed holds course toward higher interest rates

Summary

Zooming economic growth in the second quarter didn’t prompt the Federal Reserve to hasten its pace toward an interest rate hike in 2015

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The accelerating economy is practically burning rubber, but the Federal Reserve will continue to wind down its special stimulus at a measured pace, the central bank announced Wednesday, signaling no speedup in its plans to begin raising interest rates in mid-2015.

Recent information “indicates that growth in economic activity has rebounded in the second quarter,” the Federal Open Market Committee said in its announcement concluding its two-day meeting Wednesday. In addition, it noted that a pickup in inflation means price increases haved moved “somewhat closer to the Committee’s longer-run objective.”

The statement sounded a cautionary note, however, saying that the labor market still needs substantial improvement, and the recovery in housing remains slow.

The announcement came on the heels of news that the U.S. economy grew at a 4.0 percent annual pace in the second quarter, according to the Commerce Department. The stronger-than-expected growth in gross domestic product made up for shrinkage of 2.1 percent in the first quarter —  and then some, economists said, showing the winter contraction was a misstep in an otherwise steady comeback.

“While the growth rate seen in Q2 cannot be sustained, our baseline forecast still calls for growth to remain above 3.0 percent over the second half of 2014,” Regions Bank Chief Economist Richard Moody said in an analysis.

Against this backdrop, the Fed’s interest rate-setting committee voted to pare another $10 billion from its monthly bond purchases, keeping the special stimulus program on track to conclude in October. The purchases of Treasury and housing-backed bonds support low mortgage rates.

The committee also maintained its “highly accommodative” monetary policy to support improvement in the job market. The federal funds rate, the central bank’s main lever on interest rates, has stayed at the ultra-low target level of 0 percent to 0.25 percent since late 2008.

Previous comments by Fed Chair Janet Yellen indicate that the rate will stay near zero until about six months after the Fed ends its bond-buying program — if the job market and inflation remain on track.

The expected rate hike in 2015 will mean added costs for most credit card holders who carry a balance. Variable interest rates on cards are tied to banks’ prime lending rate, which is linked to the federal funds rate. Existing balances will cost more to carry when rates start going up again. However, the immediate pain will be minimal. The first upward step is likely to be a quarter-point hike, based on past FOMC moves. Most of the committee doesn’t see the rate reaching a long-run normal level of about 3.75 percent or 4 percent until after 2016.

Economic puzzle pieces come together

Wednesday’s GDP report  buttressed other signals showing the economy is gaining steam. Consumer spending grew at a 2.5 percent annual rate, a big turnaround from the first quarter’s 2.1 percent contraction. Spending on durable goods zoomed 14 percent, carried along by strong auto sales. And the GDP measure of inflation increased at a 1.9 percent rate, close to the Fed’s target of 2.0 percent.  Inflation may not sound like a worthy goal for the Fed, but too little of it is seen as a sign of weakness in the economy, particularly the labor market.

Consumer confidence is high, The Conference Board reported Tuesday, probably buoyed by the strength in fundamentals. The July Consumer Confidence Index reached its highest point since October 2007, amid optimism about jobs and income.  Confidence is an important factor underlying consumer spending, and the recent improvements “suggest that growth is likely to continue in the second half of the year,” director of economic indicators Lynn Franco said in a statement.

The unemployment rate, at 6.1 percent in June, is showing improvement, having fallen from 6.3 percent in May. July’s employment numbers are due Friday. The Fed had initially stated 6.5 percent unemployment as a target, then dropped that explicit measure in March.  Rather than use one yardstick, the Fed is keeping tabs on job creation, quit rates, and other measures of the job market’s health, Yellen has said.

One question mark remaining for the economy is housing, which has shown signs of a slowdown in its recovery. Housing prices slowed their rise in May, with 18 of 20 cities tracked by the S&P Case-Shiller Home Price Index showing deceleration. And the July consumer confidence survey found that 4.4 percent of respondents planned to buy a home sometime in the next six months, down from 5.4 percent in June and 6.9 percent in July of 2013. “The one rain cloud on an otherwise positive report is the downshift in home-buying intentions,” TD Economics Economist Ksenia Bushmeneva wrote in an analysis.

See related:Fed shrugs at inflation, holds rates steady , What an interest rate increase will cost consumers

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