Fed may stay cool on September hike even if job market glows hot

September 1, 2016 3:42 PM EDT

The Federal Reserve Building stands in Washington April 3, 2012. REUTERS/Joshua Roberts/File Photo


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By Ann Saphir

SAN FRANCISCO (Reuters) - Even if a report due Friday shows U.S. companies kept up their rapid pace of hiring in August, there is still enough resistance among policymakers at the Federal Reserve to delay an interest-rate hike at the bank's September meeting.

Reuters polling forecasts that 180,000 jobs were added last month, well above the 100,000 Fed Chair Janet Yellen says is needed to absorb newcomers to the labor market. At that rate, 2016 would be on pace for more than 2 million new jobs.

Despite those strong gains that have pushed the unemployment rate down to 4.9 percent, some at the Fed are not convinced of the need to move yet. Among them is Fed Board Governor Lael Brainard, who has warned of downside risks to the economy and said the rate hike path needs to be "shallow."

Governor Jerome Powell, who last week called for "caution" on rate hikes, and Governor Daniel Tarullo, who has signaled he wants to see more evidence that inflation is on the rise, are also skeptical of the need to move soon.

And even Yellen, who said last week that an improving labor market and signs that inflation are firming have strengthened the case for a rate hike, has said nothing on the timing, even though her more hawkish Vice Chair Stanley Fischer ignited rate hike expectations when he spoke after Yellen.

Despite the strong labor market gains, the economy's performance by other measures has been tepid. The most recent estimates put growth in the second quarter at just 1.1 percent, far less than the 2 percent in the quarter prior to last December's rate hike. The Fed's preferred inflation measure remains stuck at 1.6 percent, well below its 2-percent target.

Weakness in productivity persists as well, an increasing concern for the Federal Reserve as lower productivity will crimp the future potential rate of growth for the economy as a whole.

Reports released Thursday showed U.S. factory activity contracted in August for the first time in six months, pointing to weakness in manufacturing. Annual business investment as a proportion of gross domestic product has been running a full percentage point below its pre-recession readings.

A working paper published this week on the San Francisco Fed's website added to a gloomy view of longer-term growth prospects in the world's largest economy.

Economist John Fernald -- whose work on productivity is frequently cited by Fed policymakers including Yellen -- estimated the U.S. economy will probably only grow 1.6 percent a year over the next decade or so. That's well below the 2 percent that many Fed policymakers and economists currently expect.

"For policymakers, it suggests a low 'speed limit' for the economy," Fernald said.

IF NOT SEPTEMBER, THEN DECEMBER?

Still, some Fed officials worry that persisting with low rates to edge the unemployment rate down further could lead to uncomfortably strong upward price pressure or feed destabilizing asset bubbles.

To these policymakers, who include the reliably hawkish heads of the Cleveland and Kansas City Feds, Loretta Mester and Esther George, as well as the usually dovish chief of the Boston Fed, Eric Rosengren, raising interest rates slowly but soon is key to keeping the U.S. economy from overheating.

"If we stay too loose for too long, bad things can happen," said Barclays' economist Michael Gapen, summing up the view he sees as winning the day at the Fed.

The Fed last raised rates in December of last year, after keeping them near zero since the 2007-2009 financial crisis to encourage investment and hiring.

Several regional Fed presidents do appear to favor a near-term rate hike.

So even if September passes without a rate hike, an increase in 2016 is still very much on the table.

Financial markets also seem primed for December. Traders of Fed funds futures see a 24 percent chance of a hike this month, with a better than even chance of a move in December <0#FF:> .

(Reporting by Ann Saphir; Editing by David Chance and Andrea Ricci)



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