Fed to Raise Interest Rates Again in March, Follow Up With Fewer Hikes

U.S. Federal Reserve Chairman Janet Yellen holds a news conference to announce raised interest rates in Washington December 16. Jonathan Ernst/Reuters

(Reuters) - The U.S. Federal Reserve will raise interest rates again in the next three months, according to two-thirds of economists polled by Reuters, although many say rates won't rise as quickly next year as policymakers have suggested.

The Fed hiked rates for the first time in nearly a decade on December 16, confident the U.S. economy can stand higher borrowing costs after years of stimulus and near-zero rates, although Janet Yellen, who chairs the rate-setting Fed eral Open Market Committee, made clear future increases would be gradual.

Considering the muted outlook for inflation and oil prices, a strong dollar hurting U.S. manufacturers, and the continued fragile state of the global economy, the Fed may have to be cautious with future rate hikes.

Still, 77 of 120 economists in a snap poll conducted a couple of days after the meeting, said rates will next move higher by March. And all others but two said it would happen in the second quarter.

"Defining 'gradual' and divining how the FOMC will implement a gradual rate increase will become the new parlor game for financial markets and monetary policy wonks," William Lee, head of North American Economics at Citi, wrote in a note.

"We are confident that the actual pace of interest rate increases likely will be slower than that implied by the FOMC 'dots.' Not only are there downside risks to the outlook, but the FOMC's own predilection for responding to financial market distractions likely will dampen the pace of rate increases."

Fed policymakers - whose views are visually plotted and published by the Fed as dots - currently estimate rates at 1.25-1.50 percent by the end of 2016, 100 basis points higher than the current rate.

The median forecast among economists polled by Reuters, however, is that the fed funds target rate would be 1.00-1.25 percent by then.

Hawks and Doves

The most hawkish prediction in the poll is that rates would reach 1.75-2.00 percent by the end of next year and the most dovish said the Fed will not hike rates again at all in 2016.

Just seven of the 106 economists who gave end-year forecasts said rates would move higher than the Fed 's own dot plot, while only 2 of all the 22 primary dealers thought the FOMC dots were about right for the end-year fed funds rate. The rest said rates would be lower.

Bets in the futures market indicate traders are currently pricing in higher rates only in June.

The risk, however, is that inflation fails to rise as predicted. Core PCE inflation, which the Fed watches closely, is forecast around 1.5-1.7 percent through 2016 - similar to what Fed policymakers expect, but lower than the 2 percent target.

With oil prices likely to stay low through next year, those expectations may be optimistic. That's especially true considering the strong dollar, which is predicted to remain firm, makes imports cheaper in the U.S.

"Low inflation expectations reflect the persistent realities about the current recovery where lower commodity prices and competition from abroad have kept a lid on price pressures," wrote John Silva, chief economist at Wells Fargo.

"Inflation, measured by the PCE deflator, has averaged slightly less than 2 percent since 1994. This brings into question the value of having a 2 percent target when it has not been achieved for what could be considered the long run."

The outlook for growth is also tame, expected at a steady 2.4-2.5 percent annualized pace in each quarter over the coming year.