Fed signals it's on track for September rate hike

WASHINGTON — Citing an improving economy, the Federal Reserve signaled Wednesday it's on track to raise historically low interest rates as early as September, but that rates are likely to climb more gradually than it previously anticipated.

In a statement after a two-day meeting, Fed policymakers didn't explicitly state when they plan to boost the central bank's benchmark rate for the first time since 2006. Although Fed officials have said they expect to act this year, the statement reiterated that the precise timing will depend on the economy's performance in coming months.

"It would be wrong if we were to provide you a road map," Fed Chair Janet Yellen said at a news conference after the statement was released.

But Fed policymakers continue to expect the federal funds rate to rise from 0.125% to 0.625% by the end of the year, in line with their median estimate in March. Economists have said there almost certainly would have to be two rate hikes to reach that level, with the first likely coming in September.

But debate among the officials on the timing of the first rate increase is becoming more heated. Seven of the 17 policymakers now expect no more than one rate hike this year, up from three in March.That suggests the initial bump in rates could slip past September, says Michael Gapen, chief U.S. economist of Barclays Capital.

The Fed depicted an economy that largely has emerged from a first-quarter slump. Its statement said "economic activity has been expanding moderately after having changed little during the first quarter." It added that job gains have "picked up," household spending has been "moderate" and housing "has shown some improvement" — all upgrades over its previous assessment in March.

And it said slack in the labor market, such as the large ranks of the long-term unemployed and part-time workers who prefer full-time jobs, "diminished somewhat."

Fed officials, though, reiterated that they will hike rates only after seeing continued improvement in the labor market and being "reasonably confident" that unusually low inflation will head toward their annual 2% target by next year. The central bank's key interest rate has been near zero since the 2008 financial crisis.

"My colleagues and I would like to see more decisive evidence that a moderate pace of economic growth will be sustained," Yellen said.

But she said there are signs inflation could soon edge up, providing the Fed more a more solid basis to boost rates. "There has been some progress in the sense that energy prices appear to have stabilized," she said. Low oil prices that have held down inflation have risen in recent months.

Yellen also said, "The dollar has largely stabilized." A strong greenback has been the other big factor holding down inflation, making imports cheaper for U.S. consumers.

At the same time, policymakers lowered their forecast for the benchmark rate from 1.875% to 1.625% at the end of 2016, and from 3.125% to 2.875% in 2017, suggesting they expect a more gradual rise.

The Fed's estimate of the rate over the long term was unchanged at 3.75%.

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The caution partly reflects the bumpy start to the year. The economy shrank in the first quarter, largely because of extreme winter weather and a work slowdown at West Coast ports. Job and income growth, retail sales and the housing market all have gained momentum recently.

But even with solid growth expected in the second half of the year, Fed policymakers said Wednesday they expect the economy to expand by 1.8% to 2% in 2015, down from their March projection of 2.3% to 2.7%. In 2016, the Fed estimates the economy will grow 2.4% to 2.7%, a bit above its previous estimate of 2.3% to 2.7%.

The Fed expects the unemployment rate, now 5.5%, to fall to 5.2% to 5.3% by the end of the year, a bit higher than the 5% to 5.2% projected in March. It estimates the jobless rate will be about 5% at the end of 2016.

The Fed projects its preferred measure of inflation, which excludes food and energy costs, will be little changed at year-end, rising 1.3% to 1.4% on an annual basis. But the pace is expected to pick up to 1.6% to 1.9% in 2016, slightly faster than it previously forecast and a trend that could give policymakers added confidence to hoist rates this year.

At the same time, supporting a measured rate increase are headwinds towho growth. A strong dollar is hammering the exports of U.S. manufacturers and low oil prices have led to a pullback in drilling activity that has dampened steel production and business investment.

Many economists expect those effects to abate in the second half of the year as both the greenback and oil prices stabilize. Still, the drags on growth pose challenges for a Fed that is eager to nudge its benchmark rate toward normal levels of 3.5% to 4%, but is wary of moving too soon and derailing the recovery.

Yellen also has cited lingering vestiges from the Great Recession that argue for lower-than-normal interest rates over the long-term, such as tighter bank credit, more modest business spending and weak new-firm formation.

"Although progress has been achieved, room for further improvement remains," she said.