US Federal Reserve holds rates steady, officials eye a December hike

The Fed held rates and hinted at a hike by the end of the year, putting a rocket under Wall St and the Aussie dollar.

US Federal Reserve Chair Janet Yellen is balancing divergent views in the central bank about how to proceed on rates. Picture: AP Photo/Brennan Linsley.

The US Federal Reserve has kept official rates on hold and hinted at a hike by the end of the year, putting a rocket under both US stocks and the Australian dollar.

Wall Street bounced after the decision was released, despite some choppy trade the Dow managed to rally to close 0.9 per cent higher.

The Australian dollar was buying US75.85c one minute before the statement, then jumped to US76.24c after the decision. Despite a rocky few hours, the Aussie was trading at US76.22c at 6.10am (AEST).

“The case for an increase in the federal funds rate has strengthened,” the central bank said in its post-meeting statement, adding that it preferred to wait for more evidence of progress towards its objectives before making its next move.

The Fed raised rates from near-zero levels for the first time since the GFC in December last year, with officials expecting four increases during 2016, none of which have yet materialised. The bank’s cautious approach has come amid lacklustre inflation and a range of global risks such as the Brexit vote and fears about Chinese growth.

In another indicator that momentum for a hike within the Fed is growing, three officials dissented from the board’s decision to keep rates in a range between 0.25 per cent and 0.5 per cent and called for an increase at today’s meeting to a range of 0.5 per cent to 0.75 per cent.

One of the dissenters, Boston Fed president Eric Rosengren, made headlines earlier this month after warning there was a “reasonable case” for lifting rates to avoid overheating the economy, a reversal of an earlier dovish position.

Fed chair Dr Yellen was sensitive to these concerns in her post-meeting press conference, saying improvements in the economic data had strengthened the case for a hike.

“We’re seeing definite evidence that the economy is now expanding more strongly,” particularly compared to the start of the year, but it would be “sensible” to wait for continued progress, Dr Yellen said.

“We don’t want the economy to overheat,” she added, saying if current progress continues then gradual tightening would be appropriate.

Dr Yellen faces the challenge of uniting board members with divergent views. The Fed’s “dot plot”, which shows each official’s assessment of appropriate policy for different time periods, shows three doves think rates should remain steady for the rest of 2016.

By 2019, one official thinks rates should still be as low as the 0.5 per cent to 0.75 per cent range, while the most hawkish is calling for a rise to 3.75 per cent.

The central bank struck a more positive tone compared to some of its commentary earlier this year, when officials were worrying about slowing growth in China, global market turbulence and the possible effects of the British vote to leave the European Union.

“The labour market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year,” the Fed said in its statement. Job gains have been “solid, on average” and household spending has been “growing strongly”.

The US unemployment rate has fallen gradually to 4.9 per cent. But the Fed warned that business investment is still soft and inflation is below the bank’s 2 per cent goal after oil prices dropped sharply over the past two years.

Inflation is likely to remain low in the near term and rise to 2 per cent over the medium term, while the jobs market is set to keep strengthening, the bank said.

The Fed slightly lowered some of its economic growth forecasts in projections released after the meeting. It now expects growth of 1.8 per cent in 2016, down from a June forecast of 2 per cent.

The bank also tips longer run growth of 1.8 per cent, lower than its previous forecast of 2 per cent.

Projections of 2 per cent growth over 2017 and 2018 were unchanged.

The Fed’s next meeting on November 2 is not scheduled to include a press conference, so many observers do not expect a move then despite assurances from the bank that every meeting is “live”.

A rate increase is seen as more likely at the December 14 meeting. After today’s statement, the market is pricing in a 51.7 per cent chance of a hike then, up from 48.1 per cent yesterday, according to CME Group.

Dr Yellen faced questions about recent comments from US Republican presidential hopeful Donald Trump, who has accused the central bank chair of “doing what Obama wants her to do” by holding rates at low levels.

“Partisan politics plays no role in our decisions about the appropriate stance of monetary policy,” Dr Yellen told reporters.