Why the US Federal Reserve is sticking to low interest rates: Five things you should know

US stock markets cheered after the US central bank said in the minutes of its latest policy-seting meeting that it wants to keep interest rates close to zero for longer than expected, posting their biggest one-day gains in 2014. -- PHOTO: AFP
US stock markets cheered after the US central bank said in the minutes of its latest policy-seting meeting that it wants to keep interest rates close to zero for longer than expected, posting their biggest one-day gains in 2014. -- PHOTO: AFP

US stock markets cheered after the US central bank said in the minutes of its latest policy-seting meeting that it wants to keep interest rates close to zero for longer than expected, posting their biggest one-day gains in 2014.

Here’s what a closer look at what the minutes reveal:

1. The Fed is worried about the strengthening US dollar.

The dollar has rallied this year on the prospect of higher US interest rates.

Fed officials expressed concern in the minutes that the rising dollar could hurt the US economy and slow a needed rebound in inflation.

By pushing up the cost of US-made goods and services, a strong dollar hurts U.S. exports.

By reducing the cost of imported goods and services and putting downward pressure on commodities prices, it holds down U.S. inflation, which is is running below the Fed’s target of 2%. The biggest danger of too-low inflation is the risk of slipping into outright deflation, when prices persistently fall.

As Japan’s experience shows, deflation is both very damaging and hard to escape in economies with high debts. Since loans are fixed in nominal terms, falling wages and prices increase the burden of paying them. And once people expect prices to keep falling, they put off buying things, weakening the economy further.

2. The Fed is worried about weak economic growth in Europe and Asia

Fed officials cited disappointing growth and inflation in the euro zone that “could lead to a further appreciation of the dollar”, aming US exports less competitive there.

They added that “slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk”.

3. Fed is likely to start moving towards higher interest rates only in mid-2015.

Many Fed officials have been saying they expect the first rate increase by mid-2015. But an improving U.S. job market led some officials to press for earlier increases.

The minutes show that the twin threat of slower global growth and a strong US dollar is giving the Fed pause about moving too quickly, with the central bank saying it plans to keep its key interest rate at its current level for a "considerable time" after its bond-buying programme ends after this month.

Analysts take this to mean that the Fed is now back on track to raising rates from mid-2015 only.

4. The Fed is worried financial markets are too focused on a rate rise happening during a specific period of time.

"A number of participants noted that changes to the forward guidance might be misinterpreted as a signal of a fundamental shift in the stance of policy that could result in an unintended tightening of financial conditions," says the minutes, indicating a worry that a sell off in the markets if the Fed even hints that a rate rise will happen.

5. The Fed is eager to assure that a rate rise will be linked solely to positive economic data.

“Most participants indicated a preference for clarifying the dependence of the current forward guidance on economic data and the [Fed’s] assessment of progress toward its objectives of maximum employment and 2% inflation,” the minutes said. “A clarification along these lines was seen as likely to improve the public’s understanding of the [Fed’s] reaction function while allowing the Committee to retain flexibility to respond appropriately to changes in the economic outlook.”