Interest Rate Hike Nearing Says Federal Reserve Governor

Dennis Lockhart, the President of the Atlanta Federal Reserve spoke this morning and said that the Fed may need to raise interest rates while unemployment remains high.  Lockhart commented, “The time is approaching when it will be appropriate to consider recalibrating interest rate policy. I do not believe that time has yet arrived”.

The Federal Reserve has kept interest rates close to zero since December 2008 in order to stimulate the economy and promote lending.  Mortgage rates have been at or near historic lows since that time.

This raises the obvious question: when is the appropriate time to raise rates?  Lockhart continued: “However, as the economy continues to improve and financial markets find firmer ground, extraordinarily low policy rates will not be needed to promote recovery and will become inconsistent with maintaining price stability”.

The U.S. economy improved somewhat in May, but showed signs of deceleration.  The economy expanded at a rate of 3 percent in the first quarter of 2010, a decline from 5.6 percent growth in the fourth quarter of 2009.  The Fed forecasts a growth rate between 3-4 percent for the remainder of the year.  Analysts suggest that the growth rate needs to be around 5 percent for a year in order to reduce unemployment one percent.  Unemployment is currently at 9.9 percent, pending tomorrow’s non farms payroll report.  The consensus prediction is that around 500,000 jobs were added in May.

As to the future of the economy, Lockhart said “risks remain to a forecast of sustained growth, I think confidence is warranted”.  Lockhart also said that inflation has “remained pretty stable”.  The personal consumption expenditures price index, one of the indices the Fed uses to measure inflation rose at a rate of 0.6 percent in the first quarter, the slowest pace in over fifty years.

So what are we to make of all of this?  It seems there is a slowly changing sentiment within the Federal Reserve that monetary policy may need to be tightened before unemployment declines significantly, especially if inflation begins to rise (which doesn’t appear to be happening at the present moment).  We may be closer to a rate hike than previous imagined.  The next meeting of the Federal Reserve is scheduled for Jun 22-23.  Stay tuned.