Economic activity has rebounded, says Fed
The US Federal Reserve tapered its asset purchases by another $10bn to a monthly pace of $35bn in an upbeat statement that made no concession to signs of higher inflation. The rate-setting Federal Open Market Committee said that "economic activity has rebounded in recent months" but left its language on inflation unchanged. Coming despite a run of stronger inflation numbers in recent months, that suggests the Fed is confident there is still spare capacity in the economy, and it can keep rates low well into 2015 without triggering inflation. The FOMC voted for the cut in asset purchases by a majority of 10-0, with all of the new members – Stanley Fischer, Lael Brainard and Loretta Mester – joining the consensus. In an important sign of change to the Fed’s thinking, however, the FOMC cut its forecasts for long-run growth in the US economy and the average level of interest rates once the economy is back to normal. The long-run numbers describe some of the most fundamental parameters of the US economy – its potential to grow and the long-run price of money – and they are seldom changed. The downward revisions show the Fed is becoming more pessimistic on the long-run potential of the world’s most important economy. Its longer-run growth estimate came down fractionally, from 2.25 to 2.2 per cent, while the median estimate for interest rates in the long-run fell from 4 to 3.75 per cent. As expected, the Fed slashed its growth forecast for 2014, reflecting the extra distance the economy has to climb after cold weather caused output to fall in the first quarter. The FOMC now expects growth of 2.2 per cent this year, down from the 2.9 per cent it expected in March. It kept its 2015 and 2016 growth forecasts exactly the same, but moved its unemployment forecasts a little lower, to 6.05 per cent for the end of 2014 rather than the 6.2 per cent it predicted in March. The Fed kept its inflation forecasts almost totally unchanged, however, edging them up a fraction to 1.6 per cent for this year and predicting below target inflation all the way until the end of 2016. That suggests it does not believe stronger price numbers recently herald an inflation surge. The Fed’s interest rate forecasts on its infamous "dot chart" edged slightly upwards: whereas the median FOMC official expected end-of-2015 rates to stand at 1 per cent in March, the median is now between 1 and 1.25 per cent. The end of 2016 median was up from 2.25 per cent to 2.5 per cent. That is hard to interpret, however, since the change was fractional and Lael Brainard, one of the new governors, joined the committee too late to submit forecasts at this meeting. "Labour market indicators generally showed further improvement," said the FOMC. "Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow."