WASHINGTON – When the Federal Reserve chose Wednesday not to raise its key interest rate, it nevertheless made clear that its next move will be another increase. That stance puts it at odds with other major central banks, which are doing the reverse — seeking to ease credit to spur lending.
That policy divergence could pose risks for the global economy and may be a reason the Fed has at least slowed its march toward higher rates. Some economists think it may not be until the second half of the year before the Fed raises rates again, in part to avoid departing too far from the policies of the Bank of Japan and the European Central Bank.
The divergence reflects the contrast between a relatively solid U.S. economy — viewed as able to withstand higher borrowing rates — and weaker economies in Asia and Europe.
On Wednesday, the Fed said it was keeping its benchmark rate unchanged after having raised it from record lows in December. That was the Fed’s first hike in nearly a decade, and at the time it signalled that it expected to raise rates four more times in 2016. But there was no hike in January or March. And in March, the Fed revised its expectations to possibly just two rate hikes this year.
In its statement Wednesday, the Fed noted a slowdown in the U.S. economy, with subpar readings on consumer spending, business investment and exports. It offered no likely timetable for the next rate hike.
This Fed’s decision followed a meeting last week by the ECB in which its president, Mario Draghi, made clear he was ready to launch more stimulus efforts if needed to energize the eurozone economy. His pledge came after the ECB had already expanded its stimulus programs in March.
The Bank of Japan opted to keep its monetary stimulus mostly unchanged in its policy meeting Thursday. Japan’s central bank introduced negative rates earlier this year. Yet inflation and growth remain stuck near zero, and many are questioning the effectiveness of its “quantitative easing” efforts.
Despite keeping its policies mostly intact, the BOJ announced it would provide up to 300 billion yen ($2.75 billion) in zero-interest rate loans for disaster recovery in earthquake-stricken Kyushu. Its policy decision followed the release of data showing a pickup in industrial production but weakening consumer spending and a drift back into deflation, with core inflation at minus 0.3 per cent in March.
Analysts say they think actions by the central banks in Japan and Europe have been a factor in the Fed’s decision to slow the pace of rate hikes in the United States.
“The message the Fed is getting from Europe and Japan is that they are keeping rates extremely low and in some cases negative,” said Brian Bethune, an economics professor at Tufts University. “The Fed has to pay attention to that because they don’t want to push the dollar’s value up more.”
Indeed, since the Fed has hit the pause button on its own rate hike plans, the dollar has retreated from the highs it reached at the start of the year. The stronger dollar has been a drag on the U.S. economy by hurting exports and widening the trade deficit. A strong dollar makes U.S. goods costlier overseas.
Bethune foresees just one more rate hike this year, in September. By fall, Bethune says the U.S. economy should be growing more quickly after nearly stalling at the beginning of this year.
The Fed, in its statement Wednesday, noted that the United States is enjoying solid job gains but also that “economic activity appears to have slowed.” It said such key sectors as consumer spending, business investment and exports have weakened. At the same time, it expressed less alarm about global economic conditions than it had after its meeting in March.
In March, the Fed had cautioned that global developments “pose risks.” On Wednesday, it no longer mentioned such risks, though it said it would “closely monitor” global economic and financial developments.
The Fed repeated that it expects inflation to move toward its 2 per cent target from persistently low levels as temporary factors, like sharply lower energy prices, fade.
“The softness in U.S. economic data to start 2016 gave the Fed plenty of cover to hold off on further rate hikes now, and they held their cards close to the vest regarding upcoming meetings,” said Greg McBride, chief financial analyst at Bankrate.com.
The Fed didn’t rule out a rate hike at its next meeting in June. But neither did it say anything to prepare investors for such action.
A slowdown in China, the world’s second-largest economy after the United States — has already hurt the developing world. Europe is straining to gain momentum, and Japan is hobbled by wary consumers and an aging population.
China’s sliding economy has stabilized after worries about its growth had rocked financial markets in January. But now, a new challenge has raised international concerns: A June 23 referendum in which Britain will decide whether to leave the European Union. World leaders have warned that a British exit from the EU could threaten the global economy.
Because that vote will occur just a week after the Fed’s June 14-15 meeting, some analysts have suggested that the U.S. central bank would avoid any rate hike in June for fear it could rattle markets ahead of the British vote.