WASHINGTON—The Federal Reserve held its benchmark lending rate steady on Wednesday and officials lowered projections of how much they expect to raise short-term interest rates in the coming years, signs that persistently slow economic growth and low inflation are forcing the central bank to rethink how fast it can move rates higher.
"We are quite uncertain about where rates are heading in the longer term," Chairwoman Janet Yellen said at a press conference following the Fed's two-day policy meeting.
New projections show officials expect the fed-funds rate to rise to 0.875% by the end of 2016, according to the median projection of 17 officials. Their forecasts imply they see two rate increases this year. That is the same number of increases they saw when they last released projections in March. However a greater number of officials now see one increase, rather than two. In March only one official saw one rate increase this year and seven saw three or more. Now six officials see one increase this year and only two see three or more.
Ms. Yellen said a rate increase at the Fed's next meeting in July is "not impossible," but she doesn't know how quickly officials will gain confidence the economy is on firm footing. "We need to assure ourselves that the underlying momentum in the economy has not diminished," she said.
The central bank also sees the fed funds rate at 1.625% by the end of 2017 and 2.375% at the end of 2018, lower than quarterly projections officials released in March. Three months ago the median estimate for rates in 2018 was 3%. In the longer run, the Fed expects its benchmark rate to reach 3%, lower than the 3.25% they saw in March.
These projections aren't set in stone, but they do indicate how officials' views are changing. The Fed doesn't see rates going as high as it saw before, and it sees taking a longer time to get to the endpoint officials have in mind.
"Recent economic indicators have been mixed, suggesting our cautious approach to adjusting monetary policy remains appropriate," Ms. Yellen said.
The upcoming British referendum on whether to leave the European Union was also a factor in Fed officials' decision to leave rates unchanged, and "clearly could have consequences" for economic and global financial markets, the Fed chief added. "If it does so, it could have consequences in turn for the U.S. economic outlook that would be a factor in deciding on the appropriate path of policy," Ms. Yellen said of the so-called Brexit vote, set for June 23.
In their official policy statement released after the meeting, Fed officials repeated the refrain they've been using all year that they expect "economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate."
The central bank in December pushed its benchmark interest rate up from near zero to between 0.25% and 0.5%.
So far, the economy and financial markets haven't cooperated with plans to keep moving rates up. Early in the year, market turbulence and slow growth in economic output gave officials pause. Growth appears to have picked up and markets settled down, but now hiring and expected inflation are a cause of concern for officials, a mixed backdrop making them reluctant to act.
"The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up," the Fed said. While consumer spending has strengthened, business investment has been soft. Meantime, market indicators of expected inflation have declined, the Fed said, a development Ms. Yellen noted earlier this month was of some concern.
The tone of the Fed's official statement and projections suggest officials will need to see a quick turnaround in economic data and evidence of market resilience if they are to move promptly.
The Fed indicated its views about risks to the economy haven't shifted much since April. As they said then, officials said they would "closely monitor" inflation indicators and global economic and financial developments. That isn't a strong endorsement of the outlook. At moments of more confidence, as in December when the Fed raised short-term interest rates by a quarter percentage point, the Fed said risks to the economy were balanced.
The Fed slightly reduced its estimate for how much economic output will expand this year, shifting its March projection of 2.2% output growth to 2%. It also nudged down its 2017 growth projection by one tenth of one percent to 2%. At the same time it nudged up its inflation projection for the year to 1.4% from 1.2%, but held most of its other projections steady. The combination of relatively stable economic projections and a lower interest rate outlook suggest officials are slowly coming to the conclusion that the economy simply can't bear very high interest rates, even to achieve mediocre growth and low inflation.
Ms. Yellen has said headwinds are holding back the economy. It might be the case that those headwinds are persisting longer than she expected, or new ones are emerging, such as China's economic slowdown. Officials also have been weighing whether the economy's equilibrium interest rate—a rate at which the economy is in balance with stable inflation and low unemployment—has fallen because of long-running trends holding back growth and beyond the Fed's control, such as the retirement of workers and low productivity growth.
Fed officials last month appeared poised to raise rates in June or July. Ms. Yellen said in late May a move was probable "in the coming months" if the economy continued to strengthen.
A dismal May employment report, coupled with concerns about the June 23 British referendum on whether to leave the European Union, gave officials pause as they weigh when to next raise rates.
Employers added just 38,000 jobs in May and payroll growth in April and March was revised lower, the Labor Department said earlier this month. The share of Americans participating in the workforce also declined, and the number of employees stuck in part-time jobs rose, the report showed. Still, the number of Americans filing first-time claims for unemployment insurance remains at historically low levels.
The decision not to raise rates Wednesday follows recent comments from Ms. Yellen that officials want to wait for more assurance the hiring slowdown is not a harbinger of underlying weakness in the broader economy.
Ahead of Wednesday's release, futures markets put 1.9% probability on a rate increase in June and a 20.6% probability on a move in July. They saw just a 16% probability of two or more rate increases by December. A recent Wall Street Journal survey of business and academic economists found they expect four quarter-percentage-point increases in the fed-funds rate by the end of 2017, but there was no clear consensus on how many times the Fed would raise rates this year.
Ms. Yellen won a unanimous vote. Kansas City Fed President Esther George, who dissented in March and April in favor a rate increase, instead voted with the majority.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and Kate Davidson at kate.davidson@wsj.com
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