Fed Raises Rates, Sticks to Forecast for 2018 Increases -- Update

The Federal Reserve said it would raise short-term interest rates for the third time this year and remained on track to chart a similar path next year, signaling continuity as the central bank enters a leadership reshuffle.

Fed officials said they would increase their benchmark federal-funds rate by a quarter percentage point to a range between 1.25% and 1.5%. Officials raised their projections for economic growth and said they expect to keep lifting rates if the economy performs in line with their forecast.

Officials didn't significantly change projections about the path of interest rates or inflation even though they now expect the economy to grow faster, and the labor market to tighten further, than they did in projections released three months ago. Officials penciled in three quarter-point rate increases for next year, as they had in September, and two increases each in 2019 and 2020.

New projections show officials expect the economy to grow at a 2.5% rate this year and next, up from September projections of 2.4% and 2.1%, respectively. The Fed still expects the economy will grow at 1.8% over the long run, and Wednesday's projections show officials now expect economic growth will surpass that level through 2020.

Officials didn't change their forecasts significantly around inflation, even though they now project the unemployment rate to fall to 3.9% in 2018 and 2019, down from prior forecasts of 4.1% and below the level that they expect should prevail over the long run, which was unchanged at 4.6%.

In its postmeeting statement, the Fed's rate-setting committee described the job market as strong. "The committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong," the statement said.

Chicago Fed President Charles Evans joined Minneapolis Fed President Neel Kashkari in casting dissenting votes Wednesday because they wanted to hold rates steady.

The big question heading into their two-day meeting was how much Fed officials expected to lift rates in coming years. The prospect for new fiscal stimulus, combined with solid hiring and lofty asset values, could argue for picking up the pace to prevent the economy from overheating. But low inflation and modest wage growth could support the case for sticking with a very gradual approach.

Since officials last met in early November, Congress has moved rapidly on legislation that would cut business and individual taxes by around $1.4 trillion over the next decade. Before this week, many Fed officials refrained from building into their forecasts much prospect of fiscal stimulus because it wasn't clear what Congress would pass.

House and Senate Republicans are reconciling different versions of tax bills that have passed their respective chambers with the goal of putting a unified plan before President Donald Trump to sign by Christmas.

Fed Chairwoman Janet Yellen said during her postmeeting press conference that officials continue to expect the economy to expand at a moderate pace, adding that "while changes in tax policy will likely provide some lift to economic activity in the coming years," the magnitude and timing of the boost to growth remains uncertain.

She said most Fed officials had incorporated some fiscal stimulus from the emerging tax package into their updated economic projections, but some had done so already in their previous estimates earlier this year.

She cautioned that the new projections shouldn't be taken as estimates of the economic impact of a tax overhaul, stressing that "considerable uncertainty" about the effects remain.

Fed officials would welcome tax changes that boosted the economy's growth potential as long as that coincided with the central bank's ability to achieve its goals of full employment and stable, low inflation.

Ms. Yellen told lawmakers last month the Fed wouldn't necessarily try to prevent the economy from growing more quickly so long as fiscal policy changes spur productivity growth, which has been historically weak over the past decade.

"Look, we welcome strong growth. The Fed is not trying to stifle growth, " Ms. Yellen said. "We're worried about trends that could push inflation above our 2% objective."

Fed officials haven't said whether or to what degree they believe the specific provisions of the House and Senate bills would boost productivity, such as by encouraging capital formation and new business investment. That calculus will be especially important now that the unemployment rate -- at 4.1%, a 17-year low -- is at or below the level that many Fed officials believe will generate faster inflation.

It hasn't so far, presenting a challenge for the Fed.

On one hand, inflation has run below its annual 2% target most of this year, reaching just 1.6% in October by the central bank's preferred gauge. Another inflation measure, released Wednesday morning, showed a strong rise in energy prices but otherwise muted inflation in November.

On the other hand, with the economy so strong and more stimulus on the way, they don't want to hold rates too low for too long and cause price pressures to surge out of control or fuel asset bubbles and other financial imbalances.

Ms. Yellen told lawmakers last month modest wage increases and sluggish inflation pressures suggest "the labor market and the economy are not significantly overheated in spite of the fact that we have a very low unemployment rate."

Ms. Yellen repeated her view last month that recent low inflation readings reflect transitory factors and that as they fade, inflation will return to 2%. But she also nodded to the possibility that the Fed's understanding of inflation is awry and that weak price pressures "could reflect something more persistent."

Fed officials also are wrestling with the fact that the economy isn't responding to its rate moves as it did in the past, making it harder to discern the right policy path.

Fed increases in short-term rates used to tighten credit more broadly, causing bond yields to rise and boosting other borrowing costs, such as for mortgages, credit cards and business loans. This year, instead, financial conditions have eased, with long-term bond yields drifting lower, stock prices rising to new highs and many consumer loan rates little changed.

Fed governor Jerome Powell is poised to take the lead on confronting these challenges as Ms. Yellen's successor after her term as chairwoman ends Feb. 3. Mr. Powell was nominated last month to take the helm and is awaiting Senate confirmation, but should face no difficulty after a panel voted 22-1 last week to advance his nomination.

He has shown few signs of diverging sharply from Ms. Yellen on monetary policy, but has indicated he could offer a lighter touch on financial regulation.

Ms. Yellen has said she would resign her seat on the Fed's seven-member board once her successor takes over as chairman, which would make her the third governor to leave within a year.

Mr. Trump has filled one vacancy on the board and moved to fill a second one, in addition to nominating Mr. Powell to become chairman. Mr. Trump has two more openings to fill now and will have another after Ms. Yellen leaves next year.

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

December 13, 2017 15:28 ET (20:28 GMT)