The Federal Reserve is expected to lower its economic growth forecast this week, but falling unemployment and rising inflation could prompt policymakers to project a slightly more rapid rise in interest rates.
At a meeting today and Wednesday, the Fed is widely expected to agree to continue to trim bond purchases aimed at holding down long-term interest rates and spurring growth. The Fed's policymaking committee is likely to cut the bond buying from
Economists will be more focused on Fed forecasts. In March, policymakers predicted the economy would grow 2.8% to 3% this year. But after it shrank 1% in the first quarter amid harsh winter weather, the
At the same time, unemployment has been falling more rapidly than the Fed anticipated, in part because Baby Boomers are retiring. Feroli expects the Fed to lower its end-of-year jobless rate forecast to 5.9% to 6.1%.
Annual inflation, disconcertingly low at 1.2% in 2013, is running about 1.6% this year -- still below the Fed's 2% target but a signal the economy is picking up.
Feroli says a forecast for lower unemployment and higher inflation would mean the economy is moving closer to the Fed's central goals, so would "trump" the weaker economic growth projection. As a result, he says, policymakers likely will predict a slightly more rapid increase in interest rates next year. After keeping its benchmark rate near zero since the 2008 financial crisis, the Fed is expected to start raising it in mid-2015.
In March, bond yields rose and stocks fell after policymakers' median forecast showed interest rates at 2.25% at the end of 2016, up from 1.75% previously. Gapen says an upward revision likely would push up market rates.
"The risk is a steepening in the path" of rate hikes, Gapen says.
Further complicating the picture is that this meeting marks a shift in the policymaking committee's makeup. Former Philadelphia Fed executive
While Mester is likely more concerned about inflation and eager to raise interest rates, Brainard and Fischer have a more pro-growth approach and are less likely to boost rates quickly, Gapen says; as a result, interest rate forecasts could be unchanged.
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