USA interest rates depend on the economy

MarketWatch

WASHINGTON (MarketWatch) - Interest rates will rise when the economy begins to heat up and not a moment before, the Federal Reserve said Tuesday.

The Fed has been saying that it expects its target for short-term interest rates to remain very low for an "extended period" of time. Many outside analysts say that the "extended period" statement means the Fed won't raise rates for at least six months. Markets are now anticipating the first rate hike in September or November.

But the Fed tried to quash that guarantee on Tuesday when it released the summary of its March 16 meeting. Read our full story on the FOMC minutes.

The Fed's "extended period" pledge is "explicitly contingent on the evolution of the economy rather than on the passage of any fixed amount of calendar time," according to the minutes.

In other words, the Fed could raise rates at any time, if conditions change enough. And if the economy weakens further, or deflationary pressures mount, the Fed could keep rates low for even longer than markets now anticipate.

The FOMC is trying to meet two somewhat contradictory goals: Maximum flexibility to react quickly and maximum transparency about what it expects to do next. The Fed doesn't want to surprise markets too much, but it doesn't want to give them any airtight guarantees either.

The policy-setting committee said it is watching the economy, inflation and financial markets carefully and is ready to act immediately if necessary.

It's not necessary to act yet. In fact, the risks of raising rates too soon still outweigh the risks of starting too late, the FOMC said, because "the committee could be flexible in adjusting the magnitude and pace of tightening in response to evolving economic circumstances."

Right now, the economic recovery remains fragile, with job markets still weak, housing still on government support, and exports dependent on global conditions. Incomes haven't been growing, and government spending at the state and local level is weak. Businesses aren't hiring, or investing much in expanding their capacity.

The weak economy still requires low rates.

On the other hand, inflation isn't a problem, not yet. "Substantial resource slack was continuing to restrain cost pressures," the committee said.

Low inflation allows the Fed to keep rates low.

And fears of a new asset bubble aren't justified, the FOMC said. The Fed is still monitoring asset prices, leverage, underwriting standards and the growth of credit carefully (in contrast to its "don't ask" policy of 2001 through 2007).

So far, there are no "emerging misalignments in financial markets or widespread instances of risk-taking," the committee said.

The Fed's message today? Watch the data, not the clock.