Fed holds interest rates steady, signals could stay low for years

The Federal Reserve expects to keep its benchmark interest rate pegged near zero at least through 2023 as it strives to accelerate economic growth and drive down the unemployment rate.

The central bank also said on Wednesday it will seek to push inflation above 2 percent annually. The Fed left its benchmark short-term rate unchanged at near zero, where it has been since the pandemic intensified in March.

The Fed’s benchmark interest rate influences borrowing costs for homebuyers, credit card users, and businesses. Fed policymakers hope an extended period of low interest rates will encourage more borrowing and spending, though their new policy also carries risks of inflating stock or causing other financial market bubbles.

The Fed’s moves are occurring against the backdrop of an improving yet still weak economy, with hiring slowing and the US unemployment rate at 8.4 percent.

The Fed’s statement says that because inflation has mostly fallen below its target of 2 percent in recent years, Fed policymakers now “will aim to achieve inflation moderately above 2 percent for some time”. It also says it will keep rates at nearly zero until “inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time”.

Fed chair Jerome Powell first said last month the Fed would seek inflation above 2 percent over time, rather than just keeping it as a static goal.

The change reflects a growing concern at the Fed that in recessions, inflation often falls far below 2 percent, but it does not necessarily reach 2 percent when the economy is expanding. Over time, that means inflation on average falls further from the target. As businesses and consumers come to expect increasingly lower inflation, they act in ways that entrench slower price gains.

The Fed prefers a little inflation because that gives the central bank more room to cut or raise short-term interest rates.

In an updated set of quarterly economic projections, the Fed said it sees a smaller decline in economic growth this year, forecasting that gross domestic product (GDP) – which measures the value of goods and services produced by the economy within a specific timeframe- would fall by 3.7 percent compared with a June forecast of a 6.5 percent drop.

On employment, the Fed projected an unemployment rate at the end of the year of 7.6 percent instead of the 9.3 percent it projected in June. The unemployment rate, which hit a high of 14.7 percent in April, has declined to 8.4 percent in August.

The Fed last month made two other key changes to its strategy framework after its first-ever public review of its policies and tools, which it launched in November 2018.

Powell said last month the Fed will place greater weight on pushing unemployment lower and will no longer raise interest rates pre-emptively when the unemployment rate is low to forestall higher inflation. Instead, it will now wait for evidence that prices are rising.

Fed officials have acknowledged that economic models that predict higher inflation when unemployment is very low have been wrong, particularly since the 2008-2009 recession.

The Fed also said last month its objective to maximise employment is “a broad and inclusive goal”. That language suggests Fed officials will consider the unemployment rates of African Americans, Latinos and other disadvantaged groups as well as the overall jobless rate when contemplating interest rate changes – something the Fed has never considered before.

Democrats in Congress have introduced legislation that would require the Fed to consider racial inequities as it makes policy decisions.

The Fed also said pn Wednesday it will continue to buy about $120bn in Treasurys and mortgage-backed securities a month, in an effort to keep longer-term interest rates low. Since March, the Fed has flooded financial markets with cash by making such purchases and its balance sheet has ballooned by about $3 trillion. But with the yield on the 10-year Treasury already at just 0.67 percent, economists worry that the Fed’s bond purchases will have a limited effect going forward.

On Wednesday, the Commerce Department said retail sales rose 0.6 percent in August, the fourth straight gain but the slowest since sales started growing again in May. The figure suggests the end of a $600 supplemental weekly unemployment payment weighed on spending.

The global economy is still expected to shrink this year, but by less than previously estimated, according to a report from the Organisation for Economic Co-operation and Development (OECD), an international think-tank. The OECD now expects the world economy to shrink by 4.5 percent, up from an earlier estimate of a 6 percent contraction, mostly because of better-than-expected recoveries in the United States and China.