Federal Reserve eyes interest rate hike ‘relatively soon’

Meeting minutes show some central bankers eyeing a rate rise if the data stay upbeat, but internal divisions persist.

Federal Reserve Chair Janet Yellen. Picture: AP Photo/Jose Luis Magana.

Federal Reserve officials meeting in September laid the groundwork to raise short-term interest rates “relatively soon,” according to minutes of the meeting, although they struggled to reconcile internal divisions over the timing of the next rate move.

“Some participants believed that it would be appropriate to raise the target range for the federal funds rate relatively soon if the labour market continued to improve and economic activity strengthened, while some others preferred to wait for more convincing evidence that inflation was moving toward the Committee’s 2 per cent objective,” the Fed said in minutes of the Sept. 20-21 meeting, released Wednesday following the usual three-week lag.

The Fed held off on raising rates at the meeting even though it said the case for higher borrowing costs had “strengthened.” In a summary of economic projections released following the meeting, a majority of officials indicated it would be appropriate to raise rates once before the end of the year. The Fed last raised rates in December 2015, after keeping them near zero for several years after the 2008 financial crisis.

The minutes show the decision to stand pat was a “close call.” The Fed has two more meetings left this year, in early November and December. Investors expect the next rate move will come in December, after the US presidential election.

“It was noted that a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labour market and inflation,” the minutes said.

Data since the meeting paint a relatively upbeat picture of the US economy. The September employment report released Friday showed wages rising while more workers are coming off the sidelines. Consumer confidence also hit a post recession high last month and a gauge of manufacturing activity strengthened.

But there are also reasons for concern. The British pound fell to its lowest level ever Tuesday against a basket of global currencies as investors worried about the consequences of the UK’s exit from the European Union. That could drive another increase in the dollar, which could complicate the Fed’s tightening plans.

Meanwhile, expectations of US economic growth keep getting downgraded. The International Monetary Fund last week said it expected US output to grow 1.6 per cent in 2016, down from July’s estimate of 2.2 per cent.

Still, the minutes show Fed officials didn’t see major threats to the US economy. A majority said the economy stood about an even chance of performing better than expected as it did of performing less well than expected “with several of them indicating the risks from Brexit had receded.”

The minutes also reveal a growing divide among Fed officials who disagree over how much lower the unemployment rate can go before the economy overheats.

“Participants generally expected the unemployment rate to run somewhat below their estimates of its longer-run normal rate over the next couple of years, but they offered differing

views about the extent of slack that currently remained in the labour market,” the minutes said.

One camp argued for holding off on raising rates because it judged the labour market still had room to improve. Although the unemployment rate, at 5 per cent last month, has dropped to what the Fed considers a long-term sustainable level, a rising labour force participation rate is a sign that the workforce is still absorbing workers who are only now coming off the sidelines. Federal Reserve Chair Yellen and New York Fed President William Dudley have said they share this view.

The September employment report, released after the meeting, adds credence to that theory. It showed employers added 156,000 new jobs in September. The unemployment rate rose from 4.9 per cent in August because more people were seeking work. The labour force participation rate-the share of adults working or actively looking for jobs has risen in recent months, a sign that Americans are slowly starting to feel confident enough to re-enter the labour market.

The Fed will see two more employment reports before its December meeting. By then, Dr Yellen and others who share her view of the labour market could be satisfied that a rate increase is warranted.

Another camp pushing for a rate increase in September saw a greater risk that continuing to pump cheap money into the economy would cause the labour market to get too tight. That could push inflation above the Fed’s 2 per cent target and force officials to raise rates more rapidly and strangle the economic expansion.

In the meeting, officials in this group “referred to historical episodes when the unemployment rate appeared to have fallen well below its estimated longer-run normal level,” according to the minutes. “They observed that monetary tightening in those episodes typically had been followed by recession and a large increase in the unemployment rate.”

Boston Fed President Eric Rosengren has made this argument repeatedly in recent speeches. He joined Cleveland Fed President Loretta Mester and Kansas City Fed President Esther George in voting against the September decision to hold rates steady. It was the first time in two years that three Fed officials dissented at a meeting. In their dissents, Ms George and Ms Mester said not raising rates could damage the Fed’s credibility.

The challenge now for Dr Yellen will be to hold onto the fraying consensus she has sought to build during her time at the helm.

She and her colleagues will have to weigh the benefits of holding rates low to encourage more people back in to the workforce against the risks of letting inflation get out of hand.

In a press conference following last month’s meeting, Dr Yellen hinted at the difficult debate that took place behind closed doors.

“We struggled mightily with trying to understand one another’s points of view, and to come out at a balanced place and to act responsibly,” she said.

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