Fed clarifies guidance on short-term interest rates

WASHINGTON -- Janet Yellen tried at her first news conference as Federal Reserve chairman to clarify a question that's consumed investors: When will the Fed start raising short-term interest rates from record lows?

Yellen stressed that with the job market still weak, the Fed intends to keep short-term rates near zero for a "considerable" time and would raise them only gradually. And she said the Fed wouldn't be dictated solely by the unemployment rate, which Yellen feels overstates the health of the job market and the economy.

Those points reinforced a message the Fed delivered in a policy statement after ending a two-day meeting Wednesday. The statement said that even after it raises short-term rates, and even after the job market strengthens and inflation increases, the Fed expects its benchmark short-term rate to stay unusually low.

The statement also said the Fed will cut its monthly long-term bond purchases by $10 billion to $55 billion because it thinks the economy is steadily healing.

But Yellen might have confused investors when she tried to clarify the Fed's timetable for raising short-term rates. She suggested the Fed could start six months after it halts its monthly bond purchases, which most economists expect by year's end. That would mean short-term rates could rise by mid-2015.

A short-term rate increase would elevate borrowing costs and could hurt stock prices. Stocks fell after Yellen's mention of six months. The Dow Jones industrial average ended the day down more than 100 points.

The Fed's latest statement said its benchmark short-term rate could stay at a record low "for a considerable time" after its monthly bond purchases end. The Fed has been gradually paring its bond purchases, which have been intended to keep long-term loan rates low.

"This is the kind of term it's hard to define," Yellen said of "considerable time."

"Probably means something on the order of six months, or that type of thing."

Though stocks sold off after that remark, the Fed's statement and Yellen's comments made clear that borrowing rates for consumers and businesses could remain low for many more months. Yellen also stressed that rate increases, once they occur, would occur only incrementally.

Some analysts said they thought Yellen's reference to six months didn't really change expectations for the timing of the Fed's first rate increase.

"We're not sure the comments suggest rates would begin to rise any earlier than the mid-2015 date already priced into rate futures markets," Paul Ashworth, chief U.S. economist at Capital Economics, said in a note to clients.

In fact, Yellen devoted much of her news conference to explaining why the economy still needed a boost from the Fed. She stressed that low inflation and meager pay raises for many workers reflected a weaker recovery than the decline in the unemployment rate might indicate.

"She sounded a lot more dovish than hawkish," said John Canally, an economist at LPL Financial, referring to someone who favors low rates rather than one who worries more about inflation. "She spent a lot of time talking about how far away we are from full employment."

The Fed's benchmark short-term rate has been at a record low near zero since 2008. The Fed has previously resisted specifying the timing of a possible increase in the short-term rate.

One reason for dropping a threshold unemployment rate, as Yellen among others have noted, is that the rate can overstate the job market's health. In recent months, for example, the unemployment rate has fallen not so much because of robust hiring but because many people without a job have stopped looking for one. Once people stop looking for a job, they're no longer counted as unemployed, and the rate can fall as a result.

The Fed's previous statement had said it planned to keep short-term rates at record lows "well past" the time unemployment fell below 6.5 percent. The rate is now 6.7 percent. Several Fed officials had recently suggested scrapping the 6.5 percent threshold and instead describing more general changes in the job market and inflation that might trigger a rate increase.

The Fed's decision to drop the 6.5 percent unemployment threshold "represents the difficulty in finding the perfect economic indicator for explaining something as complex as the state of the labor market recovery and other considerations such as financial stability," James Marple, senior economist at TD Economics, wrote in a research note.

The Fed cut its benchmark short-term rate more than five years ago to a record low near zero, where it's remained since. Most analysts think the Fed will keep its target for short-term rates near zero until mid to late 2015.

The Fed also updated its economic forecasts Wednesday. Fed officials expect the U.S. economy to grow at a steady if modest pace in 2014 despite weather-related setbacks this winter. The Fed is forecasting growth of 2.8 percent to 3 percent this year, a bit lower than its December projection of between 2.8 percent and 3.2 percent.

The forecast suggests that Fed policymakers will continue to pare their monthly bond purchases, which are intended to stimulate growth by keeping interest rates low. It is doing so despite challenges the U.S. economy and financial markets face, from a brutal winter that's depressed growth, to fears about how Russia's aggression toward Ukraine might slow the global economy.

The Fed's decision came on an 8-1 vote. Narayana Kocherlakota, president of the Fed's regional bank in Minneapolis, cast the dissenting vote. Kocherlakota felt the changes the Fed made to its guidance on future short-term rate increases had weakened its credibility in raising inflation to the Fed's target of 2 percent. Inflation is now running around 1 percent.

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AP Economics Writers Josh Boak and Paul Wiseman contributed to this report.