In an update to its economic forecast, the U.S. central bank maintained its outlook for the fed funds rate to be 1.4 percent this year, implying one more rate hike of 25 basis points, and then rise further to 2.1 percent next year, unchanged from its March projection, and then rise to 2.9 percent in 2019, slightly down from its previous forecast of 3.0 percent.
The Fed has now raised its rate twice this year by a total of 50 basis points following a similar increase in March. In light of an improving economy and falling unemployment, the Fed began tightening its policy stance in December 2015 and has now raised its rate four times since then by a total of 100 basis points as the situation on the labor market slowly improves and the economy gains traction.
In contrast to its decision in May, when the Fed kept its rate steady, members of the Federal Open Market Committee (FOMC), the Fed's policy-making arm, were split in their decision today.
Eight FOMC members voted to raise the rate while Neel Kashkari voted to keep the rate.
In another sign of normalization of U.S. monetary policy, the Fed said it expects to begin "implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated."
In the wake of the global financial crises, the Fed purchased U.S.Treasuries and housing-related debt to hold down long-term rates in a move known as quantitative easing and now has a balance sheet of some $4.5 trillion.
The Fed will start the process of winding down its massive holdings of Treasuries and housing-related debt by gradually decreasing reinvestment of principal payments from those securities and issued a separate paper in which it detailed how it will slowly lower the reinvestment amount.
Payments from maturing Treasuries that initially exceed $6 billion a month will be reinvested but the cap will then increase in steps of $6 billion at 3-month intervals over 12 months until it reaches $30 billion a month.
For payments from agency debt and mortgage-backed securities, the Fed has set a cap of $4 billion month at first. This cap will then rise in steps of $4 billion at 3-month intervals over 12 months until it recaches $20 billion a month.
The Fed said it expects to reduce its reserve balances over time to a level that is "appreciably below that seen in recent years but larger than before the financial crises" as its learns about the underlying demand for reserve balances by banks.
While the Fed affirmed that is key monetary policy tool remains the fed funds rate, it said it was prepared to use all its tools, including its balance sheet, if future economic conditions were to warrant a more accommodative stance that could be achieved solely through rate cuts.
"However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reception in the Committee's target for the federal funds rate," the Fed said, addressing the issue of how it could react if the U.S. economy were to be hit by a major crises.
The U.S. unemployment rate fell to 4.3 percent in May from 4.4 percent in April for the fourth month in a row of declining joblessness and the FOMC lowered its forecast for the unemployment rate this year to 4.3 percent from a previous forecast of 4.5 percent.
For 2018 the FOMC expects the unemployment rate to ease further to 4.2 percent but then remain at that level in 2019, down from a rate of 4.5 percent seen in March.
"Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined," the FOMC said, adding that household spending had picked up in recent months and investment by businesses has expanded further.
But inflation has recently eased and the FOMC scaled back its inflation forecast.
The forecast for personal consumption expenditure, the Fed's preferred gauge, was trimmed to 1.6 percent this year from a previous 1.9 percent while it was retained at 2.0 percent - the Fed's target - in the next two years.
"Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term," the Fed said.
But while the Fed repeated its view from May that the risks to its economic outlook appear "roughly balanced," it added today that it is "monitoring inflation developments closely."
As in May, the Fed said it will gauge actual and expected economic conditions relative to its twin objectives of maximum employment and 2 percent inflation to help determine the size and future changes to the fed funds rate and expects economic conditions to evolve so gradual increases in the rate are warranted.
The Fed raised its outlook for growth this year to 2.2 percent from a previous 2.1 percent but maintained the forecast for 2018 growth at 2.1 percent and the 2019 forecast at 1.9 percent.
In the first quarter of this year, the U.S. Gross Domestic Product grew by an annual rate of 2.0 percent, unchanged from the previous quarter.
The Federal Open Market Committee (FOMC) issued the following statement:
"Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending has picked up in recent months, and business fixed investment has continued to expand. On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. 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 strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term. Near term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated. This program, which would gradually reduce the Federal Reserve's securities holdings by decreasing reinvestment of principal payments from those securities, is described in the accompanying addendum to the Committee's Policy Normalization Principles and Plans.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; and Jerome H. Powell. Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate."
The FOMC also issued the following statement regarding policy normalization principles and plans:
"All participants agreed to augment the Committee's Policy Normalization Principles and Plans by providing the following additional details regarding the approach the FOMC intends to use to reduce the Federal Reserve's holdings of Treasury and agency securities once normalization of the level of the federal funds rate is well under way.1
- The Committee intends to gradually reduce the Federal Reserve's securities holdings by decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps.
- For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.
- For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.
- The Committee also anticipates that the caps will remain in place once they reach their respective maximums so that the Federal Reserve's securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.
- Gradually reducing the Federal Reserve's securities holdings will result in a declining supply of reserve balances. The Committee currently anticipates reducing the quantity of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis; the level will reflect the banking system's demand for reserve balances and the Committee's decisions about how to implement monetary policy most efficiently and effectively in the future. The Committee expects to learn more about the underlying demand for reserves during the process of balance sheet normalization.
- The Committee affirms that changing the target range for the federal funds rate is its primary means of adjusting the stance of monetary policy. However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee's target for the federal funds rate. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate."
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