US Federal Reserve opens meeting to put an end to crisis-era policy

The US Federal Reserve building in Washington, DC.
The US Federal Reserve building in Washington, DC.PHOTO: BLOOMBERG

WASHINGTON (REUTERS) - Eight years after a devastating recession opened an era of loose US monetary policy, the Federal Reserve on Tuesday (Dec 15) began a two-day meeting at which it is expected to turn in the other direction and raise rates in an increasingly normal economy.

The decision will be released on Wednesday at 2pm (Thursday 3am, Singapore time), with markets prepared for an initial 25 basis point "lift-off" that would move the Fed's target rate from the zero lower bound to a range of between 0.25 and 0.50 percentage points. It is to be followed by a news conference by Fed chair Janet Yellen to elaborate on the central bank's latest policy statement.

Markets on Tuesday set a positive stage for the Fed's potentially historic turn. US stock indices were up around one per cent, bond yields moved higher, and analysts said that after weeks of preparation a surprise decision not to hike would be the more disruptive choice.

"Given the strength of the signals that have been sent it would be credibility destroying not to carry through," former Treasury Secretary Larry Summers, a sceptic of the need to raise rates right now, said in remarks published on Tuesday on his website.

The rate hike will separate the Fed from major central banks in Tokyo, Frankfurt, Beijing and elsewhere that are all battling to stimulate their economies and generate growth.

The initial hike expected on Wednesday will still leave US policy extremely loose, and Fed officials have signalled they will act cautiously from that point forward to nurture a tepid recovery.

Markets and analysts will focus on the exact language the Fed uses in its statement to justify the hike and describe how it will evaluate the timing of a second and subsequent steps.

Analysts at TD Securities said they expected the statement and updated economic forecasts from policymakers to take a hawkish tilt that emphasises every meeting will be "live" for a possible hike.

As of September, Fed officials expected perhaps four rate hikes next year. "The statement... should be relatively hawkish. The Fed will look to project confidence," the analysis said.

Though modest, the Fed's token first step remains fraught.

In the days to come, the Fed will have to prove that a new set of tools for managing interest rates will work as expected, see how higher US rates affect domestic and global financial conditions, and hope that weak world demand and commodity prices do not lead to an overall bout of deflation and force the Fed to reverse course.

To be considered a success, the Fed needs its rate hike to be followed next year by continued US growth, continued low unemployment, and, perhaps most in doubt, a turn higher in inflation.

For all the talk of abnormal times and changes in underlying economic fundamentals, the Fed is pinning its hopes on a very conventional premise - that the US consumer will keep spending at recent strong rates, encouraged by low unemployment and the apparent beginnings of a rise in wages. "The American consumer is in full gear and there is nothing but tailwind... They are right to be confident," said Mr Mark Zandi, chief economist with Moody's Analytics.

The turn towards higher rates has been months in the making.

The Fed under Ms Yellen has carefully stripped its policy statement of most future-oriented promises to keep rates low, along with ending crisis-era asset purchase programmes.

With unemployment falling steadily through the year, there has been steadily less justification for crisis-era policy, and a sense among policymakers that they could balance the higher rates sought by "hawks" with a slow pace of subsequent increases.

Still, opinion is not unanimous. Some Fed policymakers have said they worry the world economy is too weak for the Fed to successfully march off on its own. Labour groups on Tuesday said pockets of employment and wage growth overall are still too weak to warrant tighter financial conditions. "There's no reason to think that the pace of economic growth today is excessive and needs to be slowed because of incipient inflation," Mr Josh Bivens, research director at the Economic Policy Institute, said in calling on the Fed not to hike.

"Right now, lower unemployment that boosted wage and price growth would be an affirmatively good thing. Wages and prices are clearly growing too slowly."