By Nick Timiraos

WASHINGTON-Federal Reserve officials at their meeting earlier this month signaled they were likely to raise their benchmark short-term interest rate at their June meeting, and they debated how to characterize an evolving policy strategy that soon would no longer try to stimulate economic growth.

If the economy performs as expected, "it would likely soon be appropriate for the committee to take another step" in raising rates, according to minutes of the Fed's May 1-2 meeting, which were released Wednesday.

The Fed held its benchmark federal-funds rate steady at the May meeting in a range between 1.5% and 1.75% but looked ahead to future increases that might leave policy at a neutral level that neither spurs nor slows growth.

Officials in March penciled in three rate rises this year, including their increase that month, but were about evenly divided between those who favored three and those seeing four.

The minutes framed two important questions that will shape policy over the next few years. First, officials must determine the neutral setting for the fed-funds rate now that officials expect the economy to grow faster than is sustainable over the long run. After that, they must determine how much higher to push rates above neutral to slow growth and prevent the economy from overheating.

At the May meeting, officials said continued interest-rate increases could leave the benchmark rate "at or above their estimates of its longer-run normal level before too long," according to the minutes released Wednesday.

As a result, officials weighed how to change their postmeeting policy statement to drop language that for years has signaled the Fed's view that monetary policy has been pushing down on the gas pedal to stimulate growth.

"Some participants noted it might soon be appropriate to revise the forward-guidance language in the statement," the minutes said.

Officials suggested dropping from future statements language they have long used saying the fed-funds rate could remain "for some time, below levels that are expected to prevail in the longer run."

Fed officials first discussed in March the prospect of monetary policy moving from stimulating growth to possibly restricting growth, and the minutes released Wednesday show that conversation has taken another step forward by discussing how to characterize the evolving strategy.

San Francisco Fed President John Williams said last week he still estimates the current neutral fed-funds rate to be 2.5%. Officials' March projections show a median expectation that the fed-funds rate would settle over the long-run at around 2.9%-an approximation of neutral.

Estimates of the neutral rate matter because a consensus appears to forming among Fed officials that they should stay on their current "gradual" path of raising rates by a quarter percentage point at roughly every other until they reach neutral. The bigger debate is likely to be over what to do after they get there.

Some officials, however, have said they're not looking to push rates into restrictive territory, noting they don't want to push short-term rates higher than long-term rates, a so-called inversion of the yield curve that typically precedes a recession by a year or so.

The Fed's postmeeting statement at the May meeting caught some attention because officials added a second reference to their "symmetric" 2% inflation target, meaning they won't necessarily accelerate interest rate increases once inflation runs at or slightly above 2%.

Officials spent much of 2017 struggling to explain a surprising weakness in inflation that threatened to slow down their rate rises. The change in the statement showed how the discussion had turned to how high they might let inflation go before picking up the pace of rate increases.

Consumer prices rose to 2% in March, according to the Fed's preferred inflation gauge, while so-called core prices, which exclude the volatile food and energy sectors, rose 1.9%.

Some officials at the May meeting said a temporary period in which inflation rises modestly above 2% "would be consistent with the committee's symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective."

At the time of the May meeting, the unemployment rate had held steady since October at 4.1%. A report released after the meeting showed the rate fell to 3.9% in April.

Most officials still believe in a framework that sees an inverse relationship between unemployment and inflation. If the unemployment rate drops faster, officials will likely be more attuned to the potential for acceleration in inflation.

The minutes show officials are still unsure over the degree to which lower unemployment will fuel faster wage increases or firmer price pressures.

Some officials "saw scope for a strong labor market to continue to draw individuals into the workforce" while "a few others questioned whether tight labor markets would have a lasting positive effect on labor force participation," the minutes said.

Fiscal policy and trade policy remain considerable sources of uncertainty, the minutes showed.

Recently enacted tax cuts and a government spending increase are set to provide more stimulus to the economy. Fed officials have to sort out how much these changes could boost growth and price pressures, and the minutes show little consensus so far on those effects.

At the same time, President Donald Trump has threatened to impose tariffs and other penalties against major trading partners, which could fuel uncertainty among U.S. businesses that rely on global suppliers. Tariffs, by raising import prices, can also fuel more inflation.

Officials view "the range of possible outcomes for economic activity and inflation to be particularly wide," the minutes said. "The uncertainty surrounding trade issues could damp business sentiment and spending."

Officials have been paying close to attention for signs that stronger growth could fuel financial bubbles at the same time that they also attempt to simplify post-crisis financial regulations.

The minutes showed that some officials favor rules that would create larger cushions against a financial crisis now that the economy is on stronger footing.

While officials believe regulatory changes enacted since the 2008 financial crisis have made the financial system sturdier, "a few participants emphasized the need to build additional resilience in the financial sector at this point in the economic expansion."

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(END) Dow Jones Newswires

May 23, 2018 14:15 ET (18:15 GMT)

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