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Fed's 'nearly balanced' language no bar to Sept rate rise

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Howard Schneider

WASHINGTON (Reuters) - The U.S. Federal Reserve will not need to see balanced risks to the economy to proceed with an interest rate hike in September, according to former Fed officials and a review of central bank statements through recent turns in policy.

In its latest statement, released Wednesday, the Fed said it continued to judge the risks to the U.S. economy as "nearly balanced," meaning it still sees a greater threat of a new downturn than it does of accelerating inflation and excessive growth.

Wall Street closely watched the language as a possible tip-off to a September rate hike. Removal of the word "nearly" would have been seen as a sign that liftoff was almost certain, ending more than six years of near zero rates.

But a review of Fed statements over the past 10 years indicates the risk language used by the Fed is a poor predictor of "regime change." (Graphic: http://link.reuters.com/zyn35w)

A major change in Fed policy in June 2004 was with language about risks that is similar to that of the current statement. Prior to its decision to begin raising rates at that meeting, the Fed had for several months judged the risks to the economy as "roughly equal." It kept that characterization at the June meeting, and for nearly a year after that.

Today's situation may be similar. Potential risks from overseas are unlikely to disappear between now and the Fed's next meeting in September, for example. But that will not necessarily hold the Fed back.

"Risks seem a little tilted to the downside. China, oil, Europe," said Cornerstone Macro economist Roberto Perli, a former Fed board staffer. But the current risk language "doesn't represent a major constraint... Policy is so accommodative, to say risks are 'nearly balanced' could justify a 25 basis point increase."

The Fed will have nearly a two-month dose of data to pore over at its Sept. 16-17 meeting to either confirm the economy's strength or decide on a continued pause. That includes Thursday's report showing that U.S. growth rebounded over the last three months to a 2.3 percent annualized rate, a positive surprise.

Two employment reports, in August and September, could all but cement a rate hike if both show job growth holding steady at this year's average pace of around 208,000 per month, or could complicate the Fed's plans if they dip appreciably below that.


"To be honest, the risks are never perfectly balanced," said David Stockton, the Fed's former research director and now a fellow at the Peterson Institute for International Economics.

But "unless we get some seriously disappointing news on the labor market it looks like a Fed that is ready to move and more likely than not in September."

The Fed's annual conference in Jackson Hole will offer the central bank a chance to fine-tune, if needed, its message on the economy. Fed chair Janet Yellen, though, has said she does not plan to attend the Aug. 27-29 meeting and has no major policy speeches on the calendar at this point.

Fed officials would like to see the country's steady job growth lead to higher wages and rising prices. Yet generating more inflation may prove difficult given the drag on global demand from the downturn in China and the collapse in oil and other commodity prices. All that will make it harder for the Fed to conclude that risks are in balance.

But that does not preclude a policy move. In the past, changes in economic conditions have even caused the Fed to see risks tilted in one direction at one meeting, but then move in the other at the next.

With the housing and financial crisis in its early stages in 2007, the Fed at an August meeting that year left rates intact and said that rising inflation - not the looming economic meltdown - remained its "predominant policy concern."

A month later it cut rates by a half a percentage point, and kept doing so until it reached bottom. Rates have stayed near zero since December 2008.

More than five years later, in July 2013, the Fed for the first time since the crisis noted that the downside risks to the economy were beginning to recede.

In December 2013 the central bank upgraded the outlook with the conclusion that the Fed saw risks "as having become more nearly balanced." In March 2014, it switched to the "nearly balanced" phrase that remains today.

That phrasing may not have to change until inflation becomes a real concern. But that does not mean the Fed will delay the start of a rate increase cycle that is expected to proceed slowly over the next few years, said Jon Faust, a former adviser to Yellen and an economics professor at Johns Hopkins University.

"It is going to be hard to call the risks balanced until we are comfortably away from zero (interest rate) and closer to normal."

(Reporting by Howard Schneider; Editing by Tomasz Janowski)