Fed more confident on inflation outlook as it gears up for rate rise

The US Federal Reserve signalled it is getting more confident in the inflation outlook as it prepares for further increases in short-term interest rates in the coming months.

The US central bank said that price growth has moved close to its target and is likely to stay there in the medium term as it held short-term rates unchanged at 1.5 to 1.75 per cent.

Policymakers dropped language in previous post-meeting statements that said they were closely monitoring inflation. “Inflation on a 12-month basis is expected to run near the Committee’s symmetric 2 per cent objective over the medium term,” officials said, adding that the risks to the outlook were “roughly balanced”.

The central bank on Wednesday said it still expected growth to continue at a moderate pace and labour market conditions to remain “strong”. It highlighted firm corporate investment figures, while acknowledging that household spending growth had slowed recently. It omitted earlier language that the economy has strengthened in recent months.

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Sluggish inflation stood in the way of quicker rate rises last year, but headline inflation has recently returned to the Fed’s target of 2 per cent, leaving policymakers better placed to forge ahead with their rate-lifting plans.

Markets strongly expect the Fed to lift its target range for the federal funds rate again by another quarter-point to 1.75 to 2 per cent at its next meeting on June 12-13.

US stocks swung into positive territory and Treasuries firmed after the latest statement. The US dollar, however, turned negative for the session, having hit its highest level of 2018 shortly before the policy decision was released.

Analysts at ING said the market moves “may reflect a hint of disappointment that the Fed were not more upbeat on the economy and the threat of inflation.”

The question remains how quickly and high Jay Powell, the Fed chairman, and his colleagues boost borrowing costs as they attempt to prevent the US from overheating while keeping the economy moving at a steady pace.

Mr Powell has endorsed a “patient” approach to rate rises, and the Fed’s statement on Wednesday twice stressed that the central bank’s inflation target is “symmetrical”, in a sign that policymakers do not want to over-react to modest overshoots to their 2 per cent goal.

The median forecast from the Fed’s most recent projections points to a total of three rate increases this year, but many economists expect four upward moves. Fed forecasts show rates peaking above 3 per cent in 2020 — higher than the central bank’s estimate for the likely level of the rate in the longer term. This bullish outlook is being driven in part by America’s robust labour market, where joblessness is seen falling as low as 3.6 per cent in the coming years from its current 4.1 per cent rate. The Fed said job gains have been “strong, on average” in recent months.

In its statement it also noted that both headline and core inflation had “moved close to 2 per cent”.

The March inflation pick-up reflected in part the fading effect of steep cuts to mobile phone charges early last year. The recent jump in the cost of a barrel of oil is also adding heat to price growth. And official figures last month showed a 2.9 per cent growth in private sector wages and salaries in the first three months of the year compared with the same period a year earlier, the fastest pace since 2008.

December’s Republican-led tax cuts, coupled with higher limits on public spending this spring, will probably bolster growth going into the second quarter of the year.

On the other hand, rising trade tension between the US and its partners are clouding the picture for central bankers. US growth remains robust, but the euro area economy recorded its slowest expansion in 18 months during the first quarter. Executives at some big American companies are getting unsettled by Donald Trump’s sabre-rattling over trade. The ISM index of US factory activity slowed for a second straight month in April, according to figures this week.

The Fed made no mention of trade discussions in its statement and there were no dissents to the decision.

- Copyright The Financial Times Limited 2018