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As Fed reiterates rate pause, forecasts likely to be blown off course

By Lindsay Dunsmuir
FILE PHOTO: Federal Reserve Board building on Constitution Avenue is pictured in Washington

By Lindsay Dunsmuir

WASHINGTON (Reuters) - Friday's booming U.S. jobs report should give the Federal Reserve all it needs to stick to its plan not to cut interest rates further in the near future, so when U.S. central bankers meet this week, most of the focus will be on their outlook for next year and beyond.

But here's the rub: They often get it wrong. The coming year - with the added complications of an ongoing trade war and the U.S. presidential election - looks to be no exception.

Alongside their interest-rate decision, Fed policymakers offer up economic and rate projections at every other meeting, and the next iteration of their so-called "dot plot" is due at the end of the two-day policy meeting on Wednesday.

The Fed has made clear that it plans to stand pat on rates barring a "material" change in the U.S. economic outlook. Policymakers will assess how the three interest rate cuts they've implemented this year, most recently at the last meeting in October, filter through the economy over the coming months.

Those cuts were characterized as a pre-emptive mini-boost to the world's largest economy to mitigate the effects of slowing global growth and a 17-month-long U.S.-China trade war. The Fed hoped to offset fears that a recession in manufacturing and a drop in business investment could spread malaise to the wider economy.

So far the interest rate cuts seem to be working. The Labor Department on Friday reported U.S. job growth increased by the most in 10 months in November and recent data on housing and orders for big-ticket goods have offered a fairly upbeat assessment of the economy.

Fed policymakers are expected to hew close to their aim of a significant pause in marking out where the level of interest rates will be by the end of next year as they strive to keep the longest U.S. economic expansion on record going.

The Fed, however, has a spotty history with its year-ahead interest rate projections, having hit its median forecast only three times since they were introduced in 2011.

This year is shaping up to be their largest miss ever. Last December, the Fed projected two interest rate hikes for 2019, seeing an economy only in danger of overheating.

At the Fed's September meeting, when projections were last published, eight of the 17 policymakers already forecast interest rates to be at the level they are now through 2020.

"At the moment I think they still feel comfortable saying this is just what we promised," said Torsten Slok, chief economist at Deutsche Bank Securities.

Traders are betting that the Fed will cut rates once in 2020, according to an analysis of Fed funds futures contracts compiled by the CME Group.


(GRAPHIC: The Fed's forecasts vs reality - https://fingfx.thomsonreuters.com/gfx/mkt/12/9656/9568/Pasted%20Image.jpg)


BEST LAID PLANS, TRADE WAR BLUES

Fed policymakers' forecasts for future U.S. economic growth this time around will be in sharp focus. In September, policymakers' projections for 2020 growth ranged from 1.8% to 2.1%, consistent with what the Fed sees as the economy's potential growth rate. But if growth ebbs below trend pace next year, that could cause policymakers to ease again.

Chief among the risks to the forecast the Fed has set is the uncertainty caused by President Donald Trump's chaotic trade policy, given its role in forcing the Fed's hand this year.

After the Fed's last meeting, Chair Jerome Powell pointed to a mooted initial U.S.-China trade deal by year end as welcome evidence that economic uncertainty was diminishing for businesses that have repeatedly said the tit-for-tat tariffs were causing them to suspend investments and scrap projects.

Since then, U.S.-China trade talks have stalled and Trump unexpectedly slapped tariffs on steel and aluminium imports from Brazil and Argentina and has also threatened duties of up to 100% on French goods. On Tuesday, Trump suggested U.S.-China trade negotiations may not be resolved before the 2020 election, further clouding an already uncertain outlook.

"It's a tough situation for them because trade policy is still in flux and they're an election year sounding board for both political parties," said Satyam Panday, a senior economist at S&P Global.

What seems to be certain though is that the Fed is just as likely to change the level of interest rates in an election year as any other, according to past precedent.

Trump has repeatedly harangued the Fed this year for not lowering interest rates as much as he wants in order to bolster his economic policies, giving the impression he is pressuring an institution that prides itself on focusing only on the economic data at hand.

Powell reiterated to Trump at a meeting last month that the central bank will set monetary policy "based solely on careful, objective and non-political analysis," the Fed said in a statement at the time.

The central bank has altered monetary policy during 11 of the past 12 election years, with 2016 the exception. Economists have noted that was due to global headwinds, not the presidential election that year.



(Reporting by Lindsay Dunsmuir; Additional reporting by Howard Schneider; Editing by Dan Grebler)