Fed says U.S. economy strong enough to handle rate hike

[June 18, 2015]  By Howard Schneider and Jonathan Spicer
 
 WASHINGTON (Reuters) - The U.S. economy is growing moderately after a winter swoon and likely strong enough to support an interest rate increase by the end of the year, but concerns remain over the recovery of the labor market, U.S. Federal Reserve officials said on Wednesday.

With the economy still on track to grow as much as 2 percent for the year, the central bank's latest policy statement keeps it on track for at least one and perhaps a second rate increase later this year.

Fed Chair Janet Yellen, however, emphasized that the rate decision was still up in the air and rested squarely on further improvement in the labor market - renewing her focus on a longstanding concern.

In a press conference following the end of the Fed's two-day policy meeting, Yellen said she wanted "more decisive evidence" that labor markets were healing, and that wages would increase beyond their current "subdued pace."

Even as the Fed appeared to be approaching a decision to proceed with a rate hike as soon as September, "some cyclical weakness in the labor market remains," Yellen said, pointing to the low labor force participation rate and the high level of part-time employment.

Her comments are likely to focus even more attention on upcoming U.S. employment and wage reports, as markets look for signs that continued economic growth is translating into more jobs and higher wages.

After a weak start to the year, highlighted by a first-quarter economic contraction, policymakers said gross domestic product is poised to grow between 1.8 percent and 2.0 percent in 2015, down from a March forecast of between 2.3 percent and 2.7 percent.

The Fed also said the unemployment rate is expected to be slightly higher at the end of the year - at 5.2 percent to 5.3 percent - than previously forecast despite the continued improvement in labor markets. The unemployment rate last month was 5.5 percent.

Inflation remains low but is expected to gradually rise to its 2 percent target over the medium term, the Fed said.

Still, the policy statement and forecasts keep the Fed on track to raise rates once or twice over its four remaining policy-setting meetings this year, an outlook reaffirmed by Yellen's comments in the press conference.

"The Fed has two criteria: labor market improvement, which we continue to see, and confidence that inflation will move to its objectives. That's starting to happen," said Wayne Kaufman, chief market analyst at Phoenix Financial Services in New York.

Financial markets were little moved by the Fed's policy statement. U.S. stock indexes added to losses before rallying to close slightly higher, while prices for U.S. Treasuries inched up. The dollar was weaker against a basket of currencies.

HEDGING BETS ON DATA

Fed policymakers maintained the current near-zero interest rate for now and said a hike would be appropriate only after further improvement in the labor market and greater confidence that inflation would rise.

"Economic activity has been expanding moderately," the Fed said in its policy statement. "The pace of job gains picked up while the unemployment rate remained steady. On balance, a range of labor market indicators suggests that underutilization of labor resources diminished somewhat."

In their projections, Fed officials lowered expectations for economic growth in 2015 after accounting for the weak start to the year. It was the second time since December that the central bank has downgraded its GDP growth forecast for this year.

But 15 of 17 Fed policymakers still indicated the first rate hike should take place this year, no change from their previous set of predictions.

More significantly, policymakers' individual projections for the appropriate federal funds rate at year's end remained clustered around 0.625 percent. However, seven policymakers are now in favor of hiking rates only once or not all this year. In addition, Fed officials see slightly lower rates at the end of 2016 and 2017 than forecast in March.

With rates currently set at a range of between 0 percent and 0.25 percent, that would imply two quarter-point rate hikes between now and the end of the year, with many analysts predicting an initial hike in September.

The Fed's meeting this week was the first since the depths of the 2007-2009 financial crisis in which the outcome was not constrained by "forward guidance," the central bank's open-ended commitment to keep rates low to counter the worst downturn since the Great Depression.

(Reporting by Howard Schneider; Editing by Chizu Nomiyama and Paul Simao)

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