US Fed flags weak inflation as it holds rates

US President Donald Trump wants borrowing costs eased. Photo/Getty Images.

The Federal Reserve flagged signs that inflation has weakened despite solid growth as it reiterated its determination to be "patient" before moving interest rates again.

The US central bank kept the target range for the federal funds rate unchanged at 2.25 to 2.5 per cent on Wednesday, as widely expected in financial markets, while making a technical tweak to one of its key rates to keep borrowing costs exactly where it wants to see them.

The Fed declared that the economy is advancing at a "solid" rate overall, but it also observed that household spending and business investment decelerated in the first quarter, and inflation is now "running below" its 2 per cent target.

The Fed, led by chairman Jay Powell, is under intense pressure from President Donald Trump to ease borrowing costs to keep growth firm as the US heads for its longest-ever economic expansion. Many investors have also been counting on a rate reduction, with traders betting on a downward move before the end of the year.

However, the Fed appears to be in a holding pattern as policymakers weigh up conflicting economic evidence. Headline gross domestic product growth remains strong, at an annualised 3.2 per cent in the first quarter, and some of the overseas risks that have nagged at policymakers in recent months appear to have diminished, particularly in China.

Conditions on financial markets have also improved following the rocky end to 2018. On the other hand US private demand grew at a sluggish pace in the first three months of the year, and soft inflation is continuing to puzzle Fed officials as above-trend growth and unemployment of just 3.8 per cent fail to push year-on-year price growth durably to the 2 per cent target.

Powell said in a press conference that while the Fed would be worried if inflation ran persistently below its target, there was reason to believe that the recent weakness in price growth could prove to be transient. "We do not see a strong case for moving in either direction," he said, referring to potential changes in the benchmark federal funds rate.

A rally in the price of US Treasuries fizzled as a result, with the 10-year yield flat at 2.504 per cent by the time the press conference wrapped up, having fallen as low as 2.455 per cent earlier. The more policy-sensitive two-year note yield was up 0.014 percentage points to 2.284 per cent, from a low of 2.206 per cent earlier.

The US dollar also turned around, rising 0.12 per cent against a basket of half a dozen developed market currencies. The euro and yen both declined while the UK pound significantly trimmed its gains. US stocks were little moved, with the S&P 500 oscillating around 2,945.

"On a 12-month basis, overall inflation and inflation for items other than food and energy have declined and are running below 2 per cent," the central bank said in a statement following its latest two-day meeting.

The central bank is not releasing any new forecasts for the economy and rates on Wednesday, but further clues on the rates outlook may come when Powell hosts a press conference at 230pm US eastern time.

While the central bank kept its target range for rates unchanged, it made a technical adjustment to the rate of interest paid on excess bank reserves, which is one of the tools it uses to steer borrowing costs. This entailed a small cut in that rate to 2.35 per cent, in this hopes that this will counter an upward drift in the effective federal funds rate.

Policymakers forecast no change in rates this year when they met in March, but some Fed officials have started hinting that the central bank could consider lowering interest rates if inflation continues to disappoint — even in the absence of a major looming economic slump.

Wednesday's statement from the Federal Open Market Committee gave no clear hints either way, instead repeating past language on the Fed's decision to be patient before making any new moves.

"In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes," the central bank said in its statement.

The risk of considering rate reductions is that this could send a bearish signal about the economy outlook and end up spooking investors. The Fed is also grappling with unprecedented public lobbying from President Trump, who not only wants to see the central bank slash rates but restart its quantitative easing programme. The central bank would not wish to allow any appearance that it is buckling under presidential pressure.

Wednesday's rates decision was backed unanimously by the central bank's Federal Open Market Committee.