Federal Reserve Expects Gradual Inflation in 2015

The Federal Reserve expects inflation to rise gradually to 2%, leaving time for the central bank to wait before raising interest rates.

The Federal Reserve said Wednesday afternoon in a statement that low energy costs were keeping inflation muted, which was also causing the Federal Reserve to be patient before raising interest rates lest it cause disinflation to lead to outright deflation. “Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices,” the Fed said.

The Federal Reserve expects inflation to rise gradually to 2%, leaving time for the central bank to wait before raising interest rates.

The Federal Reserve said Wednesday afternoon in a statement that low energy costs were keeping inflation muted, which was also causing the Federal Reserve to be patient before raising interest rates lest it cause disinflation to lead to outright deflation. “Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices,” the Fed said.

The fall in energy is also helping Americans spend more on discretionary items, the Fed said. “Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power,” the bank noted in a statement. As a result, the Federal Reserve believes that U.S. economic activity is “expanding at a solid pace” and they expect that trend to continue for the foreseeable future.

Target Rate Moves Unchanged

Due to soft inflation and continued economic improvement, the Fed expects to raise interest rates later in 2015. “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation,” the Fed said in a statement.

While the timetable for the Federal Reserve’s change to interest rates is still likely to remain stable, investors and economists broadly agree that the Fed will be unable to raise the federal funds rate in the near term, and it is likely that the central bank will delay its rate hike until 2016. Market expectations have kept U.S. Treasury yields low, with the 10-year rate falling to less than 2% earlier this year. Yields fell further on the news.

Despite the market’s predictions, the Federal Reserve cautioned in its statement that it might raise rates sooner than the market expects, in a signal, that falling Treasury yields will not influence the Fed’s monetary policy. “If incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated,” the Fed said.

Market Response

While bond markets expect lower inflation, equity markets took a bearish turn after the Federal Reserve’s announcement. Wednesday afternoon, the S&P 500 erased earlier gains after the Fed statement. The Dow Jones Industrial average also saw declines.

Some analysts have anticipated that the Federal Reserve could cause equities to enter a bearish trend in 2015, as low inflation and an interest rate hike encourages less investment in stocks and more of a flight to government bonds to combat deflation. This move to safety, combined with turmoil in European currency markets, has helped to bolster the U.S. dollar and keep American equities relatively flat for the year.