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Why the Fed will only gradually raise rates this year

Federal Reserve officials expect to make more modest increases during 2016 than they had initially thought in December. Chair Janet Yellen said inflation will reach 2 percent in a few years.

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    Federal Reserve Chair Janet Yellen speaks during a news conference after the Federal Open Market Committee meeting in Washington, Wednesday, March 16, 2016. The Federal Reserve is keeping a key interest rate unchanged in light of global pressures that risk slowing the US economy. As a result, Fed officials are forecasting that they will raise rates more gradually this year than they had envisioned in December.
    Manuel Balce Ceneta/AP
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The Federal Reserve is keeping a key interest rate unchanged in light of global pressures that risk slowing the U.S. economy.

As a result, Fed officials expect to raise rates more gradually this year than they had envisioned in December. The officials now foresee two, rather than four, modest increases in their benchmark short-term rate during 2016.

The Fed said Wednesday that the economy has continued to grow moderately but that the global economy and financial markets still pose risks. Offsetting the threats, the Fed said in a statement after a policy meeting that it foresees further strengthening in the job market.

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At a news conference, Chair Janet Yellen said the Fed expects inflation, which has stayed persistently low, to reach the central bank's 2 percent target in two to three years.

Investors seemed pleased by the Fed's expectation of a more gradual pace of rate increases. The Dow Jones industrial average, which had been up slightly before the Fed's statement was issued, closed up 74 points. The yield on the 10-year Treasury note fell to 1.91 percent from 1.97 percent.

Asked at her news conference whether she thought the Fed could receive enough new economic information to raise rates at its next meeting in the last week of April, Yellen stressed, as in the past, that "every meeting is a live meeting. April remains a live meeting."

But economists said that based on the concerns the Fed expressed about the global economy, they doubted that officials would be ready to raise rates in April.

"There isn't enough time for them to see enough convincing data and do sufficient jawboning to prep markets for a rate hike," said Greg McBride, chief financial analyst at Bankrate.com.

Since raising its key rate from a record low near zero in December, the Fed has held off on raising rates again in the face of market jitters and a sharp slowdown in China. Resuming its rate hikes too soon could slow growth or rattle investors again.

In her news conference, Yellen suggested that sluggish wage growth showed that many more Americans may be available and willing to work even though the unemployment rate has reached an eight-year low of 4.9 percent. If employers perceive many candidates for job openings, they don't need to offer much higher pay to attract job seekers.

"I'm somewhat surprised we're not seeing more of a pickup in wage growth," Yellen acknowledged.

The Fed is also waiting for consumer spending to pick up, which could happen if Americans spend more of their savings from lower gas prices. This week, the government said that retail sales slipped in February and that Americans spent less in January than it had previously estimated. The report suggested that consumers remained cautious about spending despite a solid job market and lower gas prices.

The Fed's decision Wednesday was approved 9-1, with Esther George, president of the Fed's Kansas City regional bank, dissenting. The statement said George favored a quarter-point rate hike now. The Fed's updated forecasts, pointing to expectations of two rate hikes this year, are based on responses from all 17 officials who take part in the discussions, not just the 10 who vote at each meeting.

In a nod to the financial market turbulence that hit in the beginning of the year over concerns about falling oil prices and weakness in China, the Fed statement said, "Global economic and financial developments continue to pose risks."

It noted that "inflation picked up in recent months" but remained below the Fed's 2 percent target. It said prices were being kept low by the "transitory effects" of lower prices for energy and imports, which are cheaper because of a strong dollar.

The Fed has two mandates: To maximize employment and to keep prices stable. It has essentially met just one: In February, the United States added a robust 242,000 jobs — roughly the monthly average for the past six months. And the jobless rate, at 4.9 percent, is near the rate the Fed associates with full employment.

But inflation has been stuck below the Fed's target for nearly four years. Too-low inflation tends to lead people to postpone purchases, which slows consumer spending, the economy's main fuel. Subpar inflation also makes the inflation-adjusted cost of loans more expensive.

Before further raising rates, the Fed wants to see more evidence that inflation is picking up. Its preferred inflation gauge did rise in January to a 12-month increase of 1.3 percent, faster than the scant 0.7 rise over the 12-month period that ended in December. But that's still well below the Fed's target.

The government reported Wednesday that core consumer prices — which exclude volatile food and energy costs — ticked up for a second straight month. Over the past 12 months, while overall consumer inflation has risen only 1 percent, core inflation has increased 2.3 percent, the sharpest 12-month increase since 2012.

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