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Federal Reserve System

Fed continues to signal rate hike in 2015

Paul Davidson
USA TODAY
Federal Reserve Chair Janet Yellen.

The Federal Reserve gave no signal Wednesday that it's backing away from plans to raise interest rates this year, noting that it expects unusually low inflation to gradually pick up as the "transitory effects" of tumbling oil prices fade.

Disappointed investors drove down the Dow Jones industrial average 195.84 points to close at 17,191.37. "The takeaway: A Fed hike is not off the table (this year)," said Russ Koesterich, chief investment strategist at BlackRock. "And the market would like to delay that a long as it can."

In a statement after a two-day meeting, the Fed's policymaking committee upgraded its economic outlook. It cited recent "strong job gains" and said the economy "has been expanding at a solid pace." Falling gasoline prices, it added, " have boosted household purchasing power."

The unemployment rate last month fell from 5.8% to a near-normal 5.6% as employers added 252,000 jobs.

The Fed acknowledged the recent fall in consumer prices, saying market-based measures of inflation "have declined substantially in recent months" and "inflation is anticipated to decline further in the near term."

But policymakers reiterated that they expect inflation to gradually rise toward its 2% annual target over the medium term "as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate."

Some economists had cited the possibility of the Fed acknowledging the risk of inflation remaining persistently below its target. That would have signaled to financial markets the rising odds of a later rate hike.

The Fed reiterated that "it can be patient" as it weighs the timing of the first increase in its benchmark short-term rate since the 2008 financial crisis. Last month, Fed Chair Janet Yellen told reporters that means rates won't rise for at least two meetings, or until June at the earliest.

As expected, the Fed removed a reference in its December statement to a pledge to keep rates near zero "for a considerable time" after the end of a bond-buying stimulus that was halted in October.

Economists interpret the gradual shift in language as an attempt to prepare financial markets for a likely rate increase by mid-year amid an accelerating U.S. economy and labor market.

"There is nothing in the statement to suggest that lower energy prices … will necessarily stop the Fed hiking its policy rate this year," Paul Ashworth of Capital Economics wrote in a note to clients. Ashworth expects the first rate increase in June.

A possible speed bump is that oil and gasoline prices have plunged nearly 50% since summer, holding down broader inflation and putting more spending money in consumers' pockets while raising an ugly specter. Low inflation can lead to deflation, or falling wages and prices, which can prompt consumers to put off purchases and weaken the economy.

Raising rates in that environment would further dampen economic activity.

The government said last week that U.S. consumer prices fell sharply for the second straight month in December and core prices were unchanged for just the second time in four years.

Concerns about stagnant inflation were intensified by the European Central Bank's decision last week to buy 1.1 trillion euros ($1.3 trillion) in bonds by fall 2016 to further hold down interest rates and pump cash into the eurozone's struggling economy. The move further strengthened the dollar against the plunging euro, making European imports cheaper for U.S. consumers and amplifying worries of even lower U.S. inflation.

The Fed focuses on "core" inflation, which excludes volatile food and energy costs. But even that measure has been held down by the sharp drop in oil prices as manufacturers and package delivery services pass savings from lower transportation costs to customers.

Wednesday's meeting was free of the discord of recent Fed gatherings as policymakers supported the statement unanimously.

Three dissenters at last month's meeting — Philadelphia Fed President Charles Plosser, Dallas Fed Chief Richard Fisher and Minnesota Fed Chief Narayana Kocherlakota — no longer have votes following the annual turnover among regional bank presidents who vote on the Fed's policymaking committee. Plosser and Fisher are considered anti-inflation advocates, or "hawks," who favor an earlier rate increase, while Kocherlakota is a pro-growth proponent, or "dove," who prefers to wait longer.

Also losing a vote is Cleveland Fed Chief Loretta Mester, a moderate.

Replacing them are Chicago Fed President Charles Evans, a dove; Richmond Fed Chief Jeffrey Lacker, a hawk; and two moderates, San Francisco Fed President John Williams and Atlanta Fed Chief Dennis Lockhart.

Contributing: Adam Shell

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