Sharply divided Federal Reserve keeps rates unchanged, dials down 2016 forecast

United States Federal Reserve chair Janet Yellen holds a news conference following the two-day Federal Open Market Committee meeting in Washington.
United States Federal Reserve chair Janet Yellen holds a news conference following the two-day Federal Open Market Committee meeting in Washington.PHOTO: REUTERS

WASHINGTON (BLOOMBERG) - Federal Reserve chair Janet Yellen resisted mounting opposition inside and outside the US central bank and delayed an interest-rate increase again to give the economy more room to run.

While agreeing that the case for a rate rise had strengthened, Ms Yellen on Wednesday (Sept 21) argued that it made sense to put off a move for now amid signs that discouraged Americans who dropped out of the labor market are returning and looking for work.

"The economy has a little more room to run than might have been previously thought," Ms Yellen told a press conference in Washington after the Fed's two-day meeting, as she explained the decision to keep rates on hold. "That's good news."

The decision to stand pat drew dissents from three voting members of the Federal Open Market Committee - the first time that's happened since December 2014. It also comes on the heels of an accusation by Republican Party presidential nominee Donald Trump that Ms Yellen is deliberately keeping rates low to help make President Barack Obama look good in his final year in office.

When asked about such accusations, Ms Yellen repeatedly disputed that political considerations played any role in Fed decisions.

"We do not discuss politics at our meetings and we do not take politics into account in our decisions," she said.

The Fed chair also made clear that the central bank still intends to raise rates this year.

"I would expect to see that, if we continue on the current course of labor market improvement and there are no major new risks that develop," she said.

"We're still looking at a very patient FOMC despite the dissents today, and Yellen certainly leads that," said Mr Scott Anderson, chief economist at Bank of the West in San Francisco.

Not only did the Fed put off a rate increase on Wednesday, it also scaled back the number of hikes it expects next year, to two from three, according to the median forecast of FOMC participants released after the conclusion of the two-day meeting.

The Fed also downgraded its forecast for US economic growth in 2016 for the third time this year. It now projects growth this year to be 1.8 per cent. In June it forecast growth of 2 per cent.

Ms Yellen said the differences inside the FOMC mainly came down to the timing of rate increases, not to whether they should be carried out.

"We are generally pleased with how the US economy is doing," she said.

She suggested that much of the discussion centered on which set of risks was greater: overheating the economy by delaying a rate increase now, or taking a chance that inflation will remain below its 2 per cent goal by removing monetary accommodation too early.

"We had a rich, deep, serious, intellectual debate about the risks and the forecasts for the economy, and we struggled mightily with trying to understand one another's points of view," she said.

She played down concerns that the Fed's easy monetary stance was fueling bubbles in the financial markets and the economy. "In general, I would not say that asset valuations are out of line with historical norms," she said.

Mr Michael Gapen, chief US economist at Barclays Plc in New York, said Ms Yellen may be too complacent.

"Historically the Fed has had problems seeing financial instability in real time," he said.

Ms Yellen also argued that monetary policy was not exceptionally easy, in spite of the low level of interest rates. That's partly because slow productivity growth and an aging workforce have reduced the economy's potential growth rate and thus its long-run equilibrium interest rate.

"Monetary policy is only modestly accommodative," she said.

Policymakers on Wednesday lowered their estimate of the economy's long run cruising speed to 1.8 per cent from 2 per cent. They also trimmed their calculation of the long-run federal funds rate to 2.9 per cent from 3 per cent in June.

Former Fed official Jonathan Wright backed Ms Yellen's decision to give the economy more leash. 

"There is little risk and considerable potential benefit from running the labour market somewhat hot for a while" because it could draw more discouraged workers off the sidelines, said Mr Wright, who is now an economics professor at Johns Hopkins University in Baltimore.

Mr Drew Matus, deputy US chief economist at UBS Securities LLC in New York and himself a former Fed official, disagreed. Ms Yellen "might find that room to run disappears pretty quickly", he said.