Federal Reserve holds rate at zero; cites China worries

Yellen answers questions during a news conference after the meeting.
Yellen answers questions during a news conference after the meeting.AFP

WASHINGTON (AFP) - The Federal Reserve held its key interest rate locked at zero Thursday, citing worries about how the slowdown in China will hit the US economy.

Fed chairman Janet Yellen said the economy continues to grow moderately and that a rate increase could still take place before the end of the year.

However, policy makers were still focused on the spillover from China’s troubles and those in other major emerging market economies.

“A lot of our focus has been on risks around China, but not just China, emerging markets more generally and how they may spill over to the United States,” she said at a news conference following the rate announcement.

“We’ve seen significant outflows of capital from those countries, pressures on their exchange rates and concerns about their performance going forward.

“The question is whether or not there might be a risk of a more abrupt slowdown than most analysts expect.”

At the end of a two-day meeting, such concerns prevented the policy-setting Federal Open Market Committee (FOMC) from making the long-expected decision to begin raising the benchmark federal funds rate from the zero level, where it has sat since the financial crisis in 2008.

 

After years on an easy-money stance, the prospect of a Fed rate hike has added to turmoil in global markets. Both the World Bank and the International Monetary Fund have urged the Fed to be cautious as it begins tightening the reins on credit.

The decision came even as the FOMC stressed the US economy is on course and it increased its forecast for growth this year to 2.1 percent.

YEAR-END HIKE FORECAST

In the news conference, Yellen stressed that one of the two key pivots for policy, the labour market, was strengthening and that the other, inflation, was still too low but that was mainly due to “transient” effects, like the plunge in oil prices.

The FOMC statement said that household spending and business investment were increasing at a moderate pace, and that home construction was picking up, but exports were “soft”.

It also said the labour market had strengthened since the July FOMC meeting, with slack diminishing since earlier this year.

“We are looking at, as I emphasised, a US economy that has been performing well and impressing us by the pace at which it is creating jobs, and the strength of domestic demand,” Yellen said.

But, she said, “we have some concerns about negative impacts from global developments and some tightening of financial conditions.”

Nevertheless, members of the FOMC made clear, in projections accompanying their announcement Thursday, that they still expect rates to rise by the end of the year.

Of the 17 Fed officials at the meeting, 13 indicated they expect a rate hike by the end of this year, most of them pointing to a 0.25-0.50 per cent range.

The decision to hold pat was not surprising to most analysts.

“The Federal Reserve decided to err on the side of caution” though it came across as more dovish than expected, said Harm Bandholz of UniCredit.

Some were critical of the central bank for timidity.

“In one word: Paralysed,” quipped Ian Shepherdson of Pantheon Macroeconomics in a client note.

“We see a Fed which knows the labour market is tightening but can’t yet bring itself to overlook its (excessive) fears about the global outlook.”

Markets had trouble discerning what Yellen’s remarks bode for the future.

After wild swings Wall Street gave up gains and the S&P 500 ended down 0.26 per cent.

The dollar fell about 1.2 per cent, however, to US$1.1422 against the euro.