Fed could signal first rate hike since 2008

Despite tumbling oil prices that are holding down inflation, several economists expect the Federal Reserve this week to signal that it's just months away from raising short-term interest rates for first-time since the 2008 financial crisis.

After a two-day meeting concludes Wednesday afternoon, the economists predict, Fed policymakers are likely to remove from its statement an assurance that its benchmark rate is likely to stay near zero "for a considerable time" after the end of a bond-buying stimulus. The bond purchases, which were designed to hold down long-term rates, ended in October.

"It's reasonable to think about taking that language out now," says economist Jim O'Sullivan of High Frequency Economics.

In October, the Fed qualified the market-friendly phrase, stating that short-term rates could rise sooner or later than anticipated, depending on the labor market and inflation. Fed policymakers expect the first rate hike in mid-2015, based on their median forecasts from September.

Recently, however, a resurgent economy has accelerated further, growing 3.9% at an annual rate in the third quarter. And U.S. employers added 321,000 jobs in November.

Although economists don't expect the Fed to move up its timetable for the initial rate increase, they think the Fed will drop the "considerable time" language to better prepare financial markets. Based on futures contracts, investors don't expect the Fed to raise rates until next fall.

Policymakers are "likely to start trying to reshape market expectations gradually" rather than surprising investors with an abrupt move that sharply pushes up market-based rates, UBS economist Drew Matus wrote to clients.

Fed officials are already hinting of a change in language, with New York Fed President William Dudley, among others, urging "patience" in relation to the first rate increase, Goldman Sachs said in a research note.

Similarly, as the Fed prepared to raise rates in 2004, it dropped from its statement a vow to keep rates low for "a considerable period," saying instead "it can be patient" as it weighs an increase. The Fed raised its benchmark rate five months later.

Complicating the picture this time is the dizzying decline in oil and gasoline prices and a strong dollar that's making imports cheaper for U.S. consumers. Both are keeping inflation below the Fed's 2% annual target and providing a reason to keep rates lower for longer.

O'Sullivan, however, notes the Fed focuses on "core" inflation, which excludes volatile food and energy costs and is expected to drift to the Fed's target next year. Also, Dudley recently said that falling energy prices "should be a strong spur to consumer spending" as it leaves Americans with more cash.

That should boost economic growth and possibly lead to an earlier rate hike, says economist Paul Ashworth of Capitol Economics.