Fed holds rates steady in nod to global economic weakness

The Fed has policy meetings in October and December

The US Federal Reserve kept interest rates unchanged on Thursday in a nod to concerns about a weak world economy, but left open the possibility of a modest policy tightening later this year.

In what amounted to a tactical retreat, the US central bank said an array of global risks and other factors had convinced it to delay what would have been the first rate hike in nearly a decade.

"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," the Fed said in its policy statement following the end of a two-day meeting.

It added the risks to the US economy remained nearly balanced but that it was "monitoring developments abroad."

However, the central bank maintained its bias towards a rate hike sometime this year, while lowering its long-term outlook for the economy.

Fresh economic projections showed 13 of 17 Fed policymakers foresee raising rates at least once in 2015, down from 15 at the last meeting in June.

Four policymakers now believe rates should not be raised until at least 2016, compared to two who felt that way in June.

The Fed has policy meetings in October and December.

In deciding when to hike rates, the Fed repeated that it wanted to see "some further improvement in the labor market," and be "reasonably confident" that inflation will increase.

The dollar was marked lower against the euro and the yen, falling one percent against the European currency. Stocks initially edged higher before turning lower in choppy trade while the three year Treasury yield hit a one-week low.

Taken as a whole, the latest Fed projections of slower GDP growth, low unemployment and still low inflation suggest that concerns of a so-called secular stagnation may be taking root among Fed policymakers.

One policymaker even suggested a negative federal funds rate.

The median projection of the 17 policymakers showed the Fed expects the economy to grow 2.1 per cent this year, slightly faster than previously thought. However, its forecasts for GDP growth in 2016 and 2017 were downgraded.

Policymakers also forecast inflation to creep only slowly toward the Fed's 2 per cent target even as unemployment dips lower than previously expected.

They now expect the unemployment rate to hit 4.8 per cent next year, remaining at that level for as long as three years.

The Fed's projected path of interest rates shifted downward, with the long-run federal funds rate now seen at 3.5 per cent, compared to 3.75 per cent at the last policy meeting.

“The Fed has become more dovish, with growth projections revised down amid rumblings of ‘secular stagnation’.

But there’s a clear signal that, in the absence of any serious derailing of the economy, rates will rise before the year is out," said Chris Williamson of financial information services Markit.

Fed Chair Janet Yellen was scheduled to hold a press conference later Thursday afternoon to elaborate on the decision.

The vote on the policy statement was a sign of how China's economic slowdown and market slide left Fed officials unnerved about the state of the world economy.

Only Richmond Fed President Jeffrey Lacker dissented.

In recent months Fed officials like board member Jerome Powell and Atlanta Fed President Dennis Lockhart had publicly endorsed a September rate hike, forming a near majority along with longstanding inflation hawks like Lacker.

In the end, however, they were left with a muddled picture marked by low US unemployment and steady economic growth, but no sign that inflation has begun to rise towards the Fed's target.