Brexit weighs on Fed as it keeps US rates unchanged

Slower jobs growth and overseas hazards such as a possible UK exit from the European Union prompted the Federal Reserve to keep rates unchanged on Wednesday and trim back its longer-term interest-rate forecasts, in a sign of greater caution at the central bank.

The US central bank held the target range for the federal funds rate at 0.25 per cent to 0.5 per cent, where it has been since the Fed lifted rates by a quarter point from near-zero levels in December, as it assesses a mixed set of economic indicators.

The median of Fed forecasts suggests policymakers are still expecting two interest rate increases this year, but rate forecasts for 2017 and 2018 have been pared back, as has the Fed’s estimate of the longer-run policy rate.

In a sign of greater caution on the committee, Esther George, the Kansas City Fed chief, dropped her previous dissenting call for higher rates.

Until recently a number of Fed rate-setters have been signalling they want to see another rate rise as soon as this month, but Janet Yellen, the Fed chair, stressed in early June that the Federal Open Market Committee had to weigh a range of uncertainties and risks as it gauged when to move.

Among the key question marks hanging over the US outlook is the UK’s referendum on its membership of the EU — with Fed officials flagging the danger that a Brexit could ripple back and hit US growth.

Global economy

The Fed did not mention the UK vote in Wednesday’s statement, but it said that it was continuing to “closely monitor inflation indicators and global economic and financial developments.”

Its statement noted that while economic activity and household spending have picked up recently, jobs gains have diminished and market-based measures of inflation compensation had declined — even as surveys of individuals’ inflation expectations remained little changed.

Ms Yellen gave a broadly optimistic outlook about the US economy when she spoke in Philadelphia. But she also withdrew earlier guidance that she expected a rate rise “in the coming months”, suggesting the Fed now is firmly in wait-and-see mode.

Futures markets were predicting only a one-in-five chance of a move at the central bank’s next meeting in July going into Wednesday’s announcement, with slightly stronger odds in September.

Two rises

Forecasts released by the Fed showed policymakers expect two rate rises this year, leaving their median prediction for the target range centred on 0.875 per cent. Notably, however, six of the 17 participants in Wednesday’s meeting thought there may only be scope for a single increase this year.

In 2017, the median forecast is now for rates to rise to 1.625 per cent, down from 1.875 per cent in March, pointing to three rises. The median projection for 2018 is centred at 2.375 per cent, down from 3 per cent before.

Policymakers are now expecting the longer-term fed funds rate to be lower as well, with forecasts pointing to around 3 per cent compared with 3.25 per cent before, as a sluggish growth outlook weighs on forecasts.

Copyright The Financial Times Limited 2016