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Fed nods to firmer prices yet still focused on labour weakness

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Michael Flaherty and Jason Lange

WASHINGTON (Reuters) - The Federal Reserve on Wednesday reaffirmed it was in no rush to raise interest rates, even as it upgraded its assessment of the U.S. economy and expressed some comfort that inflation was moving up towards its target.

After a two-day meeting, Fed policymakers took note of both faster economic growth and a decline in the unemployment rate, but expressed concern about remaining slack in the labour market.

"Labour market conditions improved, with the unemployment rate declining further," the Fed said in a statement. "However, a range of labour market indicators suggests that there remains significant underutilisation of labour resources."

The reference confirmed that the central bank believes there is still a ways to go before benchmark borrowing costs need to move higher despite an improving outlook for jobs and prices.

Nevertheless, the shifts from the Fed's last policy statement in June marked a small step towards an eventual rate hike. The Fed has kept overnight rates near zero since December 2008 and has more than quadrupled its balance sheet to $4.4 trillion through a series of bond purchase programmes.

"It's a bit more hawkish than the previous statement," said Bricklin Dwyer, an economist at BNP Paribas. "There is clear acknowledgement of labour and inflation progress."

As widely expected, the central bank cut its monthly asset purchases to $25 billion (£14.78 billion) from $35 billion, leaving it on course to shutter the stimulus programme this fall.

U.S. stocks turned modestly higher after the statement was released on relief over the Fed's patience with rates. But government bond prices extended losses and the dollar held earlier gains as traders saw an increased chance that borrowing costs could rise a bit earlier than they had expected.

Interest rate futures suggested a greater probability of an initial rate hike early next year, but still suggested the first increase would most likely come in June 2015.

Driving home its message, the Fed reiterated that it would likely keep rates near zero for a "considerable time" after its bond buying ends. Philadelphia Federal Reserve Bank President Charles Plosser dissented because he felt the phrase did not appropriately take into account the economy's strides.


Plosser and a few other Fed officials have expressed concern the central bank risks overstaying its welcome with low rates and fuelling an unwanted level of inflation. Others, including Fed Chair Janet Yellen, are wary of moving too soon.

Yellen believes the nation's 6.1 percent unemployment rate overstates the health of the jobs market, but she warned earlier this month that a rate hike could come "sooner and be more rapid than currently envisioned" if labour markets continued to improve more quickly than anticipated.

In June, the Fed's policy-setting panel had described the jobless rate as "elevated," but it has declined further since then and officials dropped the description.

The emphasis on slack, however, indicated policymakers were looking at a broader range of indicators of the health of the jobs market and were still dissatisfied.

As notable was the growing comfort officials signalled on inflation, which they had long worried was running too low.

"The committee ... judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat," the Fed said, referring to its price objective.

The government said on Wednesday that core inflation, which strips out volatile food and energy costs, rose at a 2 percent annual rate in the second quarter, its fastest pace in more than two years, as the economy bounced back from a winter slump.

That report, which showed the economy grew at a 4 percent annual rate in the second quarter, likely amplified the debate within the Fed over how soon rates should rise.

(Reporting by Michael Flaherty and Jason Lange; Additional reporting by Gertrude Chavez in New York; Editing by Tim Ahmann and Paul Simao)