Fed upbeat on U.S. economy, cites strong job gains

[January 29, 2015]  By Michael Flaherty and Howard Schneider

WASHINGTON (Reuters) - The Federal Reserve on Wednesday said the U.S. economy was expanding "at a solid pace" with strong job gains in a signal that the central bank remains on track with its plans to raise interest rates this year.

The Fed repeated it would be "patient" in deciding when to raise benchmark borrowing costs from zero, though it also acknowledged a decline in certain inflation measures.

After a two-day meeting of the Federal Open Market Committee, policymakers struck an upbeat tone on the U.S. economy's prospects and held to their view that energy-led weakness in inflation would dissipate.

"The committee, in fact, was downright bullish on current economic conditions and the outlook," said Paul Edelstein, director of financial economics at IHS Global Insight.

In making its announcement, the Fed largely skirted slumping economies in Europe and Asia, saying only that it would take "financial and international developments" into account when determining when to raise rates, adding a reference to global markets for the first time since January 2013.

"Economic activity has been expanding at a solid pace," the Fed said in a statement that marked an upgrade to its prior assessment of a "moderate pace" of growth. "Labor market conditions have improved further, with strong job gains and a lower unemployment rate."
 

Long-term U.S. bond yields fell as some investors focused on the Fed's reference to international developments and weak inflation, potentially widening the gap between the central bank's language and what markets expect policymakers to do. The dollar strengthened against a broad basket of currencies.

"Just the inclusion of international development, that's probably perceived as dovish and the bond market is rallying probably on that," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics. O'Sullivan added that "at the end of the day, the baseline is still June for lift-off," and said that the falling unemployment rate remains a key gauge for the Fed.

'PATIENT'

The Fed's stance stands in sharp contrast to many of its peers in developed countries that have recently eased monetary policy to boost struggling economies. That was led by the European Central Bank's 1 trillion euro bond-buying program to stimulate the euro zone's economy.

"You would have thought that if you were going to really postpone (a rate hike) to 2016 there would have been some more emphasis on international events and the dollar," said John Silva, an economist at Wells Fargo in Charlotte, North Carolina.

The policy divergence has helped push the U.S. dollar to multi-year highs, a looming concern for the Fed given the move's negative impact on U.S. exporters and inflation.

Many Fed officials have pointed to a possible rate increase around mid-year, but they again left the door open to a later move. "The committee judges that it can be patient in beginning to normalize the stance of monetary policy," the Fed said.

The central bank acknowledged inflation had declined further below its 2 percent target and that market-based price gauges had fallen substantially - a more negative assessment than it gave in December.

The Fed also provided a time frame for its inflation view, saying it expects inflation to rise gradually toward its goal over the "medium term."

Fed officials have said they could being raising rates even if inflation remains stuck at a low level, confident that economic growth and job gains will eventually produce rising prices. They also view the initial "liftoff" as the start of an extended, years-long process in which rates will remain far below normal and continue to boost investment and spending.

The latest statement follows a policy shift begun in December when the Fed first said it would take a patient approach to raising rates. At that time, Fed Chair Janet Yellen made clear that "patient" meant at least two meetings.

That statement all but ruled out a move this month and in March, with investors now watching for when the 'patient' reference is dropped, which will likely signal the Fed is ready to move. While Yellen has tied any rate hike rate to incoming economic data, the June meeting and its scheduled press conference would appear to be the central bank's earliest opportunity.

In December, the Fed said that approach was consistent with its previous guidance of keeping rates near zero for a "considerable time." The statement on Wednesday removed the reference to its former guidance.

Four new regional Fed presidents - Atlanta's Dennis Lockhart, Chicago's Charles Evans, Richmond's Jeffrey Lacker and San Francisco's John Williams - rotated into voting positions for this week's policy meeting. With the exception of Lacker, an inflation hawk, they are largely dovish central bankers who have favored keeping rates low throughout the recovery from the 2007-2009 financial crisis.

Wednesday's statement was adopted without dissent, a sign that Yellen was able to reach consensus with the new voting group.

(Reporting by Michael Flaherty and Howard Schneider; Additional reporting by Luciana Lopez in New York; Editing by Tim Ahmann and Paul Simao)

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