Research and Statistics

Fed keeps rates low amid mixed economic signals


The Federal Reserve indicated that it remains on course to hike interest rates this year

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Interest rates will hold steady at rock-bottom levels for the time being, government rate-setters said Wednesday, as economic figures send mixed signals about the strength of the recovery.

In its first meeting of the year, the Federal Open Market Committee voted to keep its lever on short-term interest rates, the federal funds rate, at zero to 0.25 percent.

“Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power,” the FOMC statement said.

The statement signaled no changes in the Federal Reserve’s previous guidance that the first rate increase since the recession — known as “liftoff” — should arrive about midyear, barring sharp changes in the course of economic recovery. At its last meeting in December, the committee of central bankers said it can be “patient” about lifting interest rates. Fed Chair Janet Yellen said not to expect a hike until April at the earliest.

When it comes, the increase will affect consumers directly, including people who carry a balance on credit cards. When market rates increase, variable-rate cards will hike APRs on existing balances, making them more expensive.

The FOMC’s statement reiterated that rate increases are linked to achieving its twin economic goals of maximum employment and long-run inflation of about 2 percent.

But while the job market keeps improving, the inflation gauge is moving in the other direction, pushing the economic needle toward “cool.” Plunging fuel costs helped pull down prices by 0.4 percent in December, the second month of declines.

The FOMC characterizes the energy-induced price decline as a temporary phenomenon, and economists tend to agree.

“With the labor market continuing to improve, eventually we’re going to see [inflation] reversing,” said Richard Moody, chief economist at Regions Bank.

For now, the swing in gas prices is a boon for consumers, who will save an average of $900 apiece this year, TD Economics projects. “A significantly improved employment picture and low gas prices bode well for the outlook for consumer spending over the next year,” TD analyst Admir Kolaj wrote in a research note.

Job growth out of step with prices
According to Econ 101 textbooks, wages start to rise after a recession as employers start hiring again, bidding up the hourly wage in order to lure people back to work. Employers pass on their rising labor costs to their customers, and inflation picks up.

But while the U.S. job market continues to improve, inflation isn’t following the script. The unemployment rate fell to 5.6 percent in December, its lowest level since the prerecession days of June 2008. But average hourly earnings fell 5 cents that month, as wage gains continued to lag improvement in the jobless rate. And inflation, measured by the Consumer Price Index, has eked out a gain of just 0.8 percent for 2014.

As long as falling prices are attributed to the swing in the price of fuel, which is temporary, economists don’t expect the Fed to deviate from the midyear rate hike projection. “They’ve been pretty consistent,” Moody said.

Wednesday’s FOMC statement characterized the energy-induced break in prices as temporary. While inflation has declined “substantially” in recent months, “survey-based measures of longer-term inflation expectations have remained stable,” the committee said.

But other recent signals could point to a weakening of the economic recovery. The Commerce Department announced Tuesday that orders for durable factory output fell 3.4 percent in December, marking the fourth decrease in the past five months. Durable goods are generally higher-priced objects with a life of at least three years, such as cars, electronics and factory equipment. Falling sales of durables undermines factory jobs, potentially slowing or even reversing gains in the job market.

Global forces are contributing to the lower demand for factory output, throwing a curve into U.S. interest rate policy. Reacting to its own slow economy, Europe’s central bank announced a bigger-than-expected effort to keep interest rates low this month. It is launching an asset purchase program similar to the “quantitative easing” effort that the U.S. central bank ended in October 2014. Europe’s move reduced the value of the euro in relation to the dollar, making U.S. exports more expensive abroad.

The global environment will moderate the pace of rising rates in the U.S., some economists predict. A rising U.S. dollar will not prevent the Federal Reserve from raising the fed funds rate by half a point in late 2015,  TD Economics said in a research report, but they will only rise a further half point in 2016.

See related:Fed: Countdown to higher rates continues at ‘patient’ pace

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