Fed expects slower growth, but continues to pare stimulus

Federal Reserve officials say the U.S. economy continues to heal, but decline to signal when they might move to start raising interest rates.

The Federal Open Market Committee, the central bank's monetary-policy setting panel, said that economic activity has rebounded from a cold snap that chilled growth earlier this year. The job market has "generally showed further improvement," it said in its policy statement after concluding a two-day meeting on Wednesday.

The Fed slightly reduced its forecast for the jobless rate this year to between 6 percent and 6.1 percent, down from a previous estimate of 6.1 to 6.3 percent.

The Fed slightly raised its forecasts for short-term interest rates in 2015 and 2016, while shaving projections for interest rates in the longer-term. In its statement, the FOMC reiterated its plan to keep rates low "for a considerable time" after it shuts down its bond purchase program later this year.

Most forecasters continue to predict that a rate hike is unlikely until the first quarter of 2015 at the earliest.

"The message from the FOMC statement was that the policy outlook has not changed significantly," said Jim O'Sullivan, chief U.S. economist with High Frequency Economics, in a client note. "For now, tapering continues... while tightening is still not imminent, and when it does start it is expected to be gradual."

The Fed also continued to scale back its monthly purchases of Treasury and mortgage bonds, from $45 bilion to $35 billion. That policy, known as "quantitative easing," was implemented shortly after the 2008 financial crisis to help shore up growth. The Fed began to "taper" those purchases in December amid data showing that the economy is recovering.

Inflation remains tame, according to the Fed. It projects inflation of 1.5 percent to 1.7 percent this year, in line with the central bank's forecast this spring and below the Fed's 2 percent target. Yellen said in a press conference following the release of the policy statement that inflation is rising in line with the Fed's projections.

"I think recent readings on, for example, the CPI index have been a bit on the high side, but I think the data we're seeing is noisy," she said. "It's important to remember that, broadly speaking, inflation is evolving with the committee's expectations."

An uptick in inflation in recent months has prompted speculation, especially among investors, that the Fed could start raising interest rates sooner than expected. Prices rose a faster-than-expected 0.4 percent in May, the biggest jump in more than a year, and inflation has risen for three straight months.

Consumers are paying more for food, energy, health care, apparel and other item. Gas prices, which tend to be volatile, increased 0.7 percent last month and could rise even higher if the growing violence in Iraq threatens to disrupt global oil supplies.

The rise in inflation feeds into warnings by more hawkish Fed officials who warn that the central bank's policy of keeping short-term interest rates low risks unleashing inflation.

Other indicators suggest the economy remains slack, supporting the case by Yellen and other "doves" who say monetary policy should continue to stimulate growth.

The Fed said Wednesday it expects GDP to expand 2.1 percent to 2.3 percent this year, down from its March forecast of 2.8 percent to 3 percent growth. For 2015, it forecast growth of 3 percent to 3.2 percent, identical to its earlier projection.

Wage growth, which has lagged the rebound in corporate profits during the recovery, also remains weak, while the share of adults who are either employed or looking for work is at a historically low level.

Despite those headwinds, Yellen said a number of factors are fostering growth.

"We have a highly accommodative monetary policy, diminishing fiscal drag, easing credit conditions," she said. "We have households that are becoming more comfortable with their debt levels and more able to service debt, an improving job market, rising home prices and rising equity prices, and an improving global economy."

Stocks rose following Yellen's news conference, with the Dow Jones industrial average closing with a gain of 98 points at 16,907. The Standard & Poor's 500 reached a new high and the Nasdaq composite index also saw gains.

  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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