Global economy worries prompt Fed to hold rates at record lows

Federal Reserve Chair Janet Yellen speaking at the Federal Reserve's Wilson Conference Center on Sept 17, 2015 in Washington DC.
Federal Reserve Chair Janet Yellen speaking at the Federal Reserve's Wilson Conference Center on Sept 17, 2015 in Washington DC. PHOTO: AFP

WASHINGTON (REUTERS) - The US Federal Reserve kept interest rates unchanged on Thursday (Sept 17) in a bow to worries about the global economy, financial market volatility and sluggish inflation at home, but left open the possibility of a modest policy tightening later this year.

In what amounted to a tactical retreat, Fed chair Janet Yellen said developments in a tightly linked global economy had in effect forced the US central bank's hand.

"The outlook abroad appears to have become less certain," Ms Yellen told a news conference after the Fed's policy-setting committee released a statement following a two-day meeting.

She added that a recent fall in US stock prices and a rise in the value of the Us dollar already were tightening financial market conditions, which could slow US economic growth regardless of what the Fed does.

"In light of the heightened uncertainty abroad ... the committee judged it appropriate to wait," Yellen said.

The policy statement also nodded squarely to the global economy as a decisive variable within Ms Yellen's "data-dependent" Fed, warning that that "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," as its statement said.

Fed chair Janet Yellen expanded on this at the press conference, drawing an explicit line between the decision and developments in China. "We focused particularly on China and emerging markets," Ms Yellen said. "We've long expected to see some slowing in China as they rebalanced their economy."

But the Fed maintained its bias towards a rate hike sometime this year, while lowering its long-term outlook for the economy.

Fresh economic projections showed 13 of 17 Fed policymakers foresee raising rates at least once in 2015, down from 15 at the last meeting in June.

Traders in futures markets cut bets that the central bank would lift rates by December to around a 47 per cent probability, from 64 per cent before the release of the policy statement.

"We're in the same situation we were in before, which is uncertainty about when are they going to move," said John Bonnell, a senior portfolio manager at USAA Investments in San Antonio, Texas.

Four Fed policymakers now say rates should not be raised until at least 2016, compared to two who felt that way in June. The Fed has policy meetings in October and December.

In deciding when to hike rates, the Fed repeated it wanted to see "some further improvement in the labor market," and be "reasonably confident" that inflation will increase.

The US dollar fell sharply against a basket of currencies after the release of the statement. Stocks initially edged higher before falling and ending the trading session lower. Prices for US Treasuries rose.

Taken as a whole, the latest Fed projections of slower GDP growth, low unemployment and continuing low inflation suggest that concerns of a so-called secular stagnation may be taking root among policymakers. One policymaker even suggested a negative federal funds rate.

The median projection of the 17 policymakers showed the Fed expects the economy to grow 2.1 per cent this year, slightly faster than previously thought. However, its forecasts for GDP growth in 2016 and 2017 were downgraded.

The Fed also forecast inflation would creep only slowly toward its 2 per cent target even as unemployment dips lower than previously expected. It sees the unemployment rate hitting 4.8 per cent next year and remaining at that level for as long as three years.

The Fed's projected interest rate path shifted downward, with the long-run federal funds rate now seen at 3.5 per cent, compared to 3.75 per cent at the last policy meeting.

Fed officials like board member Jerome Powell and Atlanta Fed President Dennis Lockhart in recent months had publicly endorsed a September rate hike, forming a near majority along with longstanding inflation hawks like Richmond Fed President Jeffrey Lacker. Only Lacker, who wanted to raise rates by a quarter percentage point, dissented on Thursday.