Fed seen raising rates mid-year even with low inflation: economists

[WASHINGTON] Federal Reserve officials will look past low inflation and stay focused on raising interest rates around mid-year as they meet this week, according to a narrow majority of economists surveyed by Bloomberg News.

Some 45 per cent of 53 economists in the survey said the central bank will raise the benchmark lending rate in June. Six per cent said July, while 30 per cent said the Fed will wait until September for the first increase since 2006. Fed officials last month said they expect to raise the rate this year.

"The economy is increasingly showing signs that it is no longer in crisis mode," said John Ryding, chief economist at RDQ Economics in New York, who is forecasting a June increase. "Low inflation is mainly an oil-price story" and that "will be good for the US economy." The policy-setting Federal Open Market Committee, meeting for the first time in 2015 on Tuesday and Wednesday in Washington, will be challenged by reports contrasting the encouraging performance of the US economy with a global outlook that has darkened since they met in December.

The European Central Bank last week announced it would spend 60 billion euros (S$90 billion) a month starting in March on purchases of debt to ward off the threat of deflation - a damaging, widespread decline of prices - in the euro area.

The euro has weakened almost 3 per cent against the dollar since the ECB's Jan 22 decision, creating a potential headwind for US growth by making its exports more expensive. Economists in the survey said the Fed would shrug off the impact of a stronger dollar.

Some 28 survey participants, or 53 per cent, said the rise in the dollar against major currencies makes no difference to the timing of the first rate increase.

Similarly, 66 per cent said the ECB's decision to start a quantitative-easing program worth at least 1.1 trillion euros makes no difference to the timing of the first Fed rate increase.

Any tweaks in the Fed's communications on the current outlook for the economy and US monetary policy will also be constrained by the lack of a press conference by Fed Chair Janet Yellen after the conclusion of the meeting on Wednesday.

A clear majority of 72 per cent of respondents said they don't expect the phrasing in the policy statement released at the end of the meeting to signal a significant shift toward the risk that inflation is too low.

"I suspect that the Fed is loath at this point to introduce anything that takes away from the thesis of a mid-year rate increase," said Guy Lebas, managing director at Janney Montgomery Scott LLC in Philadelphia.

The US unemployment rate stood at 5.6 per cent in December, close to central bankers' 5.2 per cent to 5.5 per cent estimate for full employment.

Oil prices have fallen about 20 per cent since Fed officials last met Dec 17, and economists are marking up their estimates for growth this year as lower petrol prices leave households with more money to spend on other things.

A separate survey shows forecasters expect US economic growth of 3.2 per cent this year, according to the median estimate, compared with 2.9 per cent estimated last month.

At the same time, market signals are flashing warnings about the pace of growth and inflation around the world. Yields on US government 10-year notes have fallen to 1.83 per cent from 2.14 per cent since the FOMC last met.

Yields on longer-term government debt are below 1 per cent in France, Germany, Sweden and Japan. A market-based measure of expectations for inflation over the five years starting in 2020 has declined to 1.83 per cent from 1.92 per cent when Fed officials last met.

US central bankers in December forecast an expansion of 2.6 per cent to 3 per cent this year with inflation rising just 1 per cent to 1.6 per cent as measured by the personal consumption expenditures price index.

Yellen said at her press conference following the December meeting that central bankers would have to be "reasonably confident" that inflation would move back to their 2 per cent target over time to begin raising interest rates. She also said there would be no move for at least the next couple of meetings, or not before late-April.

Some 66 per cent, or 35 of 53 economists in the survey, said they didn't expect the Fed's preferred measure of inflation, the personal consumption expenditures price index, to show three consecutive readings of 2 per cent or higher until the second quarter of 2016 or later.

The price index rose 1.2 per cent in December from a year earlier and has been under the Fed's 2 per cent target for 31 straight months.

Eventually, Fed officials will have to acknowledge that inflation is too low and will that as a reason to delay liftoff, said Robert Brusca, president of Fact & Opinion Economics in New York, among the 29 per cent of economists who held that view.

"Yellen is going to do hopscotch from one indicator to another as she starts to emphasize inflation," said Brusca.

"There are demographic factors and there are technology factors and there are international competitiveness factors that are responsible for wages being as weak as they are," Brusca added. "You aren't going to change the demographics and you aren't going to change the technology and the international factors are still in place." Economists were split on the pace of tightening.

Some 34 per cent said the benchmark lending rate would be between 0.75 per cent and 1 per cent at the end of 2015, while 32 per cent said it would be between 0.5 and 0.75 per cent.

BLOOMBERG