The Federal Reserve on Wednesday signaled that the U.S. economy is nearly ready to stand on its own but sought to assure investors that the process would be gradual.
Officials at the nation’s central bank voted unanimously to leave the benchmark federal funds rate unchanged at zero during their regular policy meeting in Washington. But their own economic forecasts show most believe they will raise it for the first time in nearly a decade sometime this year, according to documents released Wednesday.
The fed funds rate influences the cost of borrowing for everything from buying a new home to building a new factory. Since 2008, it has been at virtually zero in the hopes that easy money would stimulate demand among consumers and businesses and bolster the recovery. Raising the rate would amount to a vote of confidence in the country’s economic health.
“My colleagues and I would like to see more decisive evidence that a moderate pace of economic growth will be sustained,” Yellen said in a press conference after the Fed's meeting.
In its official policy statement, the Fed pointed out that the economy is creating jobs at a faster clip, the housing sector is improving and that consumers are spending moderately more money. The central bank also acknowledged that businesses have been wary of investing and exports are weak. But it noted that the fall in energy prices, which weighed on inflation, have stabilized.
The Fed’s cautious optimism comes despite downgraded forecasts for the economy this year. The central bank lowered its forecast for growth to just between 1.8 and 2 percent, below its spring projection of 2.3 to 2.7 percent. Meanwhile, it raised the forecast for the unemployment rate to 5.2 to 5.3 percent from 5 to 5.2 percent in the spring. Estimates of inflation held steady at 0.6 to 0.8 percent.
The revised numbers reflect the stumble in the recovery during the first quarter, but central bank officials have largely written it off as temporary. Their projections for growth, employment and inflation next year were virtually unchanged.
Officials’ expectations for the fed funds rate this year also drifted lower. In the spring, forecasts ranged up to nearly 2 percent by year end. Wednesday’s data showed officials nearly evenly divided between just under 1 percent and slightly above 0.25 percent — reflecting debate over the exact timing of liftoff.
More officials believe the Fed should only raise interest rates once this year, the forecasts suggest. Still, the median estimate for the fed funds rate remained unchanged at 0.625 percent, implying two increases. Two officials believed the Fed should not move at all until 2016.
Most economists believe the Fed will move when it meets in September, though markets show the most likely month as December, according to prices on fed funds futures before Wednesday’s announcement.
The Fed has cautioned that the timing of its decision to hike interest rates will depend on how the recovery unfolds. If economic data comes in better than expected, the central bank may move more quickly and more aggressively. If the recovery is weak, it can delay or slow down the process.
“Our actual policy decisions over time will depend on evolving economic conditions," Yellen said.
The Fed also believes that the precise timing of the first increase matters mainly to Wall Street and makes little difference in the broader economy. Inside the central bank, the debate has shifted to the pace of subsequent rate hikes. The median estimate for the target rate at the end of 2016 is lower than in the spring, suggesting a shallower path of increases.
"Although policy will be data-dependent, economic conditions are currently anticipated to evolve in a manner that will warrant only gradual increases in the federal funds rate," Yellen said.
But the Fed has cautioned that markets should not expect an smooth elevator ride back to normal. Officials have been walking a fine line between assuring investors that the process will likely be slow and well telegraphed while preparing them for a potentially bumpy transition.
There is "no plan to follow any type of mechanical approach to raising the federal funds rate," she said. Later, Yellen added that "we cannot promise there will not be volatility" in the markets.
In 2013, when the central bank tried to signal that it would soon stop pumping money into the recovery, markets shuddered and Main Street suffered. Interest rates spiked, forcing the Fed to move gingerly when it finally began to wind down its purchases of long-term bonds the next year.