US interest rates stay on hold

In September, the US Federal Reserve decided not to increase official interest rates from the close to zero level that they have stood at since the depths of the Global Financial Crisis.

The Federal Open Market Committee has a dual statutory mandate to foster maximum employment and price stability and the Committee took the decision that an increase in interest rates was not appropriate at this time based on its assessment of economic and financial conditions.

The decision was essentially a balancing act between positive domestic data versus issues of concern on the global arena. US economic activity is expanding at a moderate pace, with the housing sector, household spending and business fixed investment all improving, although net exports were soft. There were also solid jobs gains and declining unemployment; however inflation continued to run below the Committee's objective of 2%, reflecting declines in energy prices.

The offsetting factors appeared to be turbulence in global financial markets and economies. China, which endured a 40% retreat in its share market that sparked fears of lower global growth than previously expected, was not specifically named as the reason for keeping rates on hold, but the Committee did say these developments may restrain economic activity and put further downward pressure on inflation.

Reasonable confidence about inflation moving back to 2% in the medium term, as well as a touch further improvement in the US labour market, are the key triggers to finally raising official interest rates.

Federal Reserve chair, Janet Yellen, has, however, indicated that a rate rise remains imminent because the current global economic weakness is unlikely to be significant enough to deter the Committee's plans to raise interest rates before year end.
Interestingly, she also highlighted the risks of not raising rates. "Continuing to hold short-term interest rates near zero well after real activity has returned to normal and headwinds have faded, could encourage excessive leverage and other forms of inappropriate risk-taking that might undermine financial stability," said Ms Yellen. "The more prudent strategy is to begin tightening in a timely fashion at a gradual pace."

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