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Fed stays cautious on recovery

January 26, 2011|Reuters

The Federal Reserve gave the U.S. economy a lukewarm assessment Wednesday despite recent signs the recovery was strengthening, saying high unemployment still justified its $600 billion bond-buying program.

In a statement following its two-day policy-setting meeting, the central bank also said measures of underlying inflation were "somewhat low" although it acknowledged a rise in commodity prices that has fueled global inflation worries.

"The economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions," the Fed said.

The language was slightly more upbeat than the words the Fed employed after its last meeting in December, when it said the recovery had been insufficient to lower unemployment at all. The government has since reported that the jobless rate fell to 9.4 percent last month from 9.8 percent in November.

The Fed's calm view of price pressures is in sharp contrast to the European Central Bank, whose President Jean-Claude Trichet has warned that the commodity price surge poses a inflation threat. The Fed, instead, has focused on core U.S. inflation, which is at a five-decade low.

"Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward," the U.S. central bank said.

The U.S. dollar slipped and prices for U.S. government rose on the statement, while stocks held gains. U.S. interest rate futures showed traders paring bets that the central bank would start raising overnight interest rates this year.

"The statement doesn't acknowledge the uptick in U.S. economic data that we've seen over recent weeks to the extent that we had expected that it would," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.

Along with a decision to leave its interest rate target near zero, the Fed reiterated the target would likely stay ultra-low for an extended period.

No Fed officials dissented. Financial markets had been watching closely for any dissent given a new lineup of Fed voters that includes two vocal inflation hawks.

The Fed cut rates to near zero in December 2008 and bought $1.7 trillion in longer-term securities to provide an additional boost to the economy and battle deflation risks.

After the recovery appeared to falter in mid-2010, the central bank launched a new program to buy $600 billion in U.S. government debt to drive borrowing costs down further in the hope of lowering an unemployment rate stuck near 10 percent.

The Fed's statement made clear policymakers remain concerned about the headwinds confronting the recovery.

"Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit," the Fed said.

Fed officials brought fresh economic forecasts to the table this week, but they will not be made public until Feb. 16.

The U.S. economy is expected to have expanded by a reasonably robust 3.5 percent annual rate in the fourth quarter after growing at a 2.6 percent pace in the July-September period. Similar vigor early in the new year may make the case for an ultra-accommodative monetary policy harder to sustain, even if unemployment remains relatively high.

Low levels of inflation outside of food and energy costs had spurred worry at the Fed about a vicious cycle of falling prices and declining spending and investment, but the brighter economic signs have left Fed officials breathing easier.

"We're seeing some improvement in the labor market. I think deflation risk has receded considerably. And so we're moving in the right direction," Fed Chairman Ben Bernanke said on Jan. 13.

Still, officials realize it will take a long time to fill the hole left by the 2007-2009 recession and they have set a high bar for any changes to their bond buying plan, which markets expect to be completed in full.

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