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Fed set to end one crisis chapter even as global risks rise

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[October 29, 2014]  By Howard Schneider

WASHINGTON (Reuters) - The U.S. Federal Reserve on Wednesday is expected to shutter its bond-buying program, closing one controversial chapter in its crisis response even as it struggles to manage a full return to normal monetary policy.

The Fed is likely to announce at the end of a two-day meeting that it will no longer add to its holdings of Treasury bonds and mortgage-backed securities, halting the final $15 billion in monthly purchases under a program that at its peak pumped $85 billion a month into the financial system.

An important symbolic step, the end of the purchases still leaves the Fed far from a normal posture. Its balance sheet has swollen to more than $4 trillion, interest rates remain at zero, and, if anything, recent events have increased the risk the U.S. central bank may need to keep propping up the economy for longer than had been expected just a few weeks ago.

The statement the Fed will issue at 2 p.m. (1800 GMT) will be read carefully for signs of how weak inflation, ebbing global growth and recent financial market volatility have influenced U.S. policymakers. There is no news conference scheduled after the meeting and no fresh economic forecasts from Fed officials.

"They are worried about the economy, the global one," and are likely to leave much of their language intact rather than signal progress towards a rate hike, Morgan Stanley analyst Vincent Reinhart wrote in a preview of the meeting.

 

Attention will focus on whether the Fed's statement continues to refer to "significant" slack in the U.S. labor market, and whether it retains language indicating rates will remain low for a "considerable time," as most economists expect.

Paul Edelstein, director of financial economics at IHS Global Insight, said the Fed may also need to acknowledge the inflation outlook is weakening.

"They have been kind of wrong about inflation lately," Edelstein said. "It would behoove them to do something - signal to markets they are not going to tolerate inflation and inflation expectations persistently below 2 percent."

Fed officials have largely stuck to forecasts that the U.S. economy will grow around 3 percent this year, with inflation poised to move gradually back to their 2 percent goal.

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However, slower-than-expected global growth and falling oil prices have called that inflation outlook into question.

Investors have recently pushed their expectations for an initial rate hike back to late next year as a result, although a number of top Fed officials recently said they think the U.S. central bank is still on track to bump up borrowing costs in mid-2015.

The Fed's third round of bond buying closes to mixed reviews. Officials argue it helped hold down long-term interest rates, keeping borrowing costs cheaper for companies and households. Others maintain it did little more than prop up stock prices.

The end of the program won't immediately lead to a decline in the Fed's bloated balance sheet.

For now, it plans to continue reinvesting the proceeds of securities that mature, part of an effort to keep many aspects of its monetary accommodation in place. As it stands, officials do not plan to allow the Fed's balance sheet to decline until after interest rates begin to rise.

(Reporting by Howard Schneider; Editing by Tim Ahmann and Paul Simao)

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