IMF Says Fed May Have Scope for Zero Rate Past Mid-2015

The Federal Reserve may have scope to keep interest rates at zero for longer than investors anticipate as inflation stays muted and a 2014 slowdown prolongs the labor-market recovery, the International Monetary Fund said.

The IMF cut its U.S. growth forecast for this year to 1.7 percent from 2 percent predicted in June, citing a first-quarter contraction, after a 1.9 percent advance last year. The fund left its 2015 forecast at 3 percent, the fastest expansion since 2005.

“Even with that relatively good growth outlook, we still see there’s a lot of slack in the economy,” Nigel Chalk, deputy director of the IMF’s western hemisphere department, said today on a conference call.

The nation’s jobless rate fell to 6.1 percent in June, down from 6.6 percent in January, even as harsh winter weather contributed to a 2.9 percent contraction in gross domestic product from January through March. While the job market is weaker than the unemployment rate implies, there’s “meaningful rebound” under way, the staff report said.

“With better growth prospects, the U.S. should see steady progress in job creation but headline unemployment is expected to decline only slowly,” the report said.

Faster Growth

The IMF’s 2014 growth forecast matches the consensus outlook of economists surveyed by Bloomberg News. For the rest of this year, the IMF predicts growth will accelerate 3 percent to 3.5 percent.

The projected rebound will “well exceed potential for the foreseeable future,” the IMF said in its so-called Article IV report. The fund said potential growth is about 2 percent, down from more than 3 percent in the decade before the 2008 global financial crisis.

The IMF’s report was released ahead of a July 29-30 meeting of the Federal Open Market Committee, the central bank’s policy-setting body. Fed officials are winding down a program of asset purchases aimed at keeping long-term rates low and debating the timing for the first policy rate increase since 2006.

The FOMC has indicated that it expects to start raising the federal funds rate from zero next year as long as the economy performs as projected. Fed Chair Janet Yellen reiterated to lawmakers on July 16 that the central bank will probably keep the rate low for a “considerable period” after ending monthly the bond purchases, which she said may be announced after the October policy meeting.

Market’s Expectation

Derivative traders are wagering the Fed will first lift the benchmark rate around the middle of next year. Federal funds futures contracts traded at the CME Group Inc. signal a 58.6 percent probability the central bank will boost its zero-to-0.25 percent target rate in July 2015, according to Bloomberg calculations.

The IMF sees the labor market of the world’s largest economy as “reasonably healthy.”

Still, stagnant wages, elevated long-term unemployment rates and weak labor participation may limit growth, the report said, forecasting the U.S. will reach full employment by the end of 2017 as inflationary pressures stay “muted.”

“If true, policy rates could afford to stay at zero for longer than the mid-2015 date currently foreseen by markets,” the IMF staff wrote.

If inflation rises before full employment is reached, “there could be room for the Fed to tolerate a temporary and modest rise of inflation above the 2 percent target,” the staff said in the report.

The IMF urged the Fed to improve its communications to help alleviate uncertainty about the direction of policy, saying officials should consider more press conferences and releasing a quarterly monetary policy report.

Reducing Uncertainty

In a separate report released today, IMF staff looked at the Fed’s forward guidance on policy, which has moved away from using thresholds such as the unemployment rate. In March the Fed abandoned a pledge to keep rates “exceptionally low” as long as the jobless rate was above 6.5 percent to instead say it will take into account “a wide range of information” on labor markets and inflation.

“While qualitative forward guidance will provide the FOMC with more policy flexibility, it also suggests a greater premium on clear and systematic communication to avoid an increase in policy uncertainty as lift-off approaches,” IMF staff wrote.

Tomorrow the IMF is scheduled to release revisions to its World Economic Outlook report.

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