US interest rates will stay at rock-bottom levels for almost another three years, the Federal Reserve promised last night, signalling its belief that a return to economic prosperity was still over the horizon.
The central bank's interest rate-setting committee surprised financial markets by extending by an additional 18 months the period for which it expects to hold official rates – called the federal funds rate – near zero.
Unemployment is simply not coming down fast enough, the Fed has decided, and any risk of inflation is now so remote that it was free to pursue even looser monetary policy. In fact, the Fed formalised its long-held 2 per cent target for underlying US inflation, and said the actual rate will most likely stay below that for the foreseeable future.
Economic conditions "are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014", the Federal Open Market Committee said yesterday. Previously, it had said interest rates would stay at near-zero until mid-2013.
Bond traders reacted immediately, pushing down interest rates across financial markets in a move that could quickly feed through into lower mortgage rates for American borrowers and cheaper loans for businesses.
Ben Bernanke, the chairman of the Federal Reserve, said that, "unless there is a substantial strengthening of the economy in the near term, it's a pretty good guess we will be keeping rates low for some time."
The increasingly doveish tone of the Fed's rate-setting committee came despite more optimistic forecasts for US unemployment among the bank's staffers and board members. For the first time, the Fed also published the range of forecasts for interest rates made by 17 top officials. These showed wide disagreement, and although a majority of officials predicted the first rate hike will come in 2014, two predicted it would not come until 2016.
The publication of a formal inflation target, common among central banks in other countries, is a victory for Mr Bernanke, who has long argued for such a move. The Fed did not set a target for US unemployment, which it said was mainly affected by structural factors rather than monetary policy.