Fed's Yellen: Economy is ready for rate hike

Paul Davidson | USA TODAY

Show Caption Hide Caption Yellen: Labor market improving Federal Reserve Chair Janet Yellen addressed the latest unemployment figures at The Economic Club in Washington.

Federal Reserve Chair Janet Yellen signaled Wednesday that the Fed is all but certain to raise interest rates this month for the first time in nearly a decade, saying that gains in the economy and labor market have met the central bank's goals.

Her comments at the Economic Club of Washington amount to the strongest indication the Fed has provided so far that it will take action at a December 15-16 meeting.

Yellen noted that Fed policymakers have said they'll increase its benchmark rate when they've seen "some further improvement in the labor market and were reasonably confident that inflation" would move up to the Fed's annual 2% target over the medium-term.

"I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market," Yellen said. Those gains, combined with market inflation expectations, "serve to bolster my confidence in the return of inflation to 2%" as the effects of low energy and import prices fade.

Fed policymakers have provided signs in recent weeks that they likely will bump up rates this month. Financial markets are now giving 75% odds of a rate increase.The Fed's benchmark rate has been near zero since the 2008 financial crisis.

Fed policymakers, though, remain divided over the timing of the first hike, with some arguing it's more prudent to hold off because a premature move could derail the recovery and expose the economy to unexpected shocks. By contrast, the Fed could raise rates more rapidly than it anticipates to catch up to quickly rising inflation.

Yellen's acknowledged those concerns but highlighted the risks of waiting too long and noted that the effects of monetary policy on the economy work with a lag.

"Were the (Fed) to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals" of about 5% unemployment and 2% inflation. That, she said, could push the economy into recession. And keeping rates near zero too long "could also encourage excessive risk-taking and thus undermine financial stability."

The unemployment rate already is at 5%, down from 10% in 2009, Yellen said. She noted the Fed's preferred measure of inflation -- which strips out volatile food and energy costs -- is just 1.4%, well below its target. But she said she expects inflation to rise to the Fed's 2% benchmark "over the next few years" as the effects of low oil prices and a strong dollar fade. A strong dollar keeps import prices low for U.S. consumers.

She noted that while weakness overseas has curtailed exports, consumer spending and the broader domestic economy remain strong. And risks from the global turmoil "have lessened since late summer," she added.

Economic data since the Fed's October meeting has shown continued improvement in the labor market, Yellen said. Job growth weakened in August and September, but Yellen cited October's robust gains of 271,000, which she says brought the monthly average since June to a healthy 195,000.

Yellen added that the Fed will receive additional reports over the next two weeks that it will consider as well, including Friday's eagerly anticipated jobs report for November. But economists say it will take an unusually disappointing report to throw the Fed off course. Economists surveyed by Bloomberg expect 200,000 job gains.

Yellen also indicated that rate increases will be gradual over the next few years and that the benchmark rate will remain below normal even after the labor market and inflation have fully met the Fed's targets. Although Fed policymakers' forecasts indicate they're likely to boost rates by a quarter of a percentage point every other meeting, or four times a year, Yellen said the Fed has no plans "to proceed over time in such a mechanical, calendar based way." She said each move will depend on economic data.

"The economy has come a long way (toward the Fed's goals)," she said. Lifting rates will be a "testament, also, to how far the economy has come in recovering from the effects of the financial crisis and the Great Recession. In that sense, it is a day that I expect we are all looking forward to."