Fed redefines the unemployment range it considers acceptable
WASHINGTON (AP) — The Federal Reserve was in a tough spot: The February U.S. unemployment rate of 5.5 percent is right where the Fed had been saying inflation would likely start to accelerate. Yet inflation remains even lower than the Fed wants it to be.
So on Wednesday, the Fed simply moved the goalposts.
It now says unemployment could fall as low as 5 percent to 5.2 percent before inflation pressures would probably start to build. That's down from its previous range of 5.2 percent to 5.5 percent.
That shift is a big reason many analysts think the Fed has in effect postponed the date when it will start raising the short-term interest rate it controls. Many now expect it to start raising rates in September or even later after having previously predicted June.
Investors welcomed the possibility of lower rates for longer, sending the Dow Jones industrial average up 227 points.
"With the stroke of a pen, rather than being at the top end of full employment ... we're farther away," said Allen Sinai, chief economist at Decision Economics.
As the unemployment rate falls, it typically reaches a level at which employers must raise pay to find qualified workers to hire. Those employers then raise prices to offset the higher wages they're paying, which usually accelerates inflation. The unemployment rate that triggers higher prices is generally considered "full employment."
At her news conference Wednesday, Chair Janet Yellen said the Fed's new lower range for acceptable unemployment "suggests that (Fed officials) are seeing more slack in the economy now than they previously did."
That, in turn, implies that rates will rise more slowly than many had assumed. Separate forecasts by Fed officials show they now expect the Fed's short-term interest rate to be much lower at the end of this year and next than they thought in December.
The Fed had little choice but to make the change to acknowledge economic reality, analysts said. Paychecks for most Americans have barely kept up with inflation since the recession officially ended 5½ years ago.
"If we were even close to full employment, we would be seeing more pressure on hourly earnings by now," said Richard Moody, chief economist at Regions Financial. "They are just adjusting to that reality."
The Fed had lowered the upper end of its full-employment range as recently as June 2014. But the lower end had stood at 5.2 percent since April 2011, according to Michael Gapen, an economist at Barclays.
There are no clear guidelines for what the full employment rate is. In the late 1990s, the Fed chose not to raise rates even as the unemployment rate fell. It eventually touched 3.9 percent without igniting inflation.
It "does move around a bit and is unobservable," said Paul Ashworth, chief U.S. economist at Capital Economics. "It is a genuine puzzle."
The Fed made other changes to its forecasts Wednesday after its latest policy meeting ended. It now predicts:
— Growth will be much slower through 2017 than it predicted in December. It now foresees growth of roughly 2.5 percent this year and next, down from 2.8 percent and 2.75 percent, respectively. Growth will then slow to about 2.2 percent in 2017, down from 2.4 percent, it predicts.
— Even with slower growth, unemployment will keep falling. The Fed now forecasts that the unemployment rate will be about 5.1 percent at year's end, down from its previous estimate of 5.25 percent. Next year, it will drop to 5 percent and in 2017 to 4.95 percent, it predicts.
— Inflation will be even lower this year, between 0.6 percent and 0.8 percent, down from the 1 percent to 1.6 percent it forecast in December. But Fed policymakers didn't cut their outlook as much in later years: They still project that inflation will be near their 2 percent target in 2016 and 2017.