|Fed tapers bond purchases by US$10b from January, but reaffirms commitment to low interest rates
The US Federal Reserve has sent its strongest signal of confidence in the economy since the Great Recession struck six years ago: it has decided the economy is finally strong enough to withstand a slight pullback in the stimulus.
Yet the Fed also made clear it is hardly withdrawing its support for an economy that remains below full health. Chairman Ben Bernanke (Pictured) stressed that the Fed would still work to keep borrowing rates low, AP reports.
At his final news conference as chairman before he leaves in January, Bernanke managed a delicate balance: he announced a long-awaited and long-feared pullback in the stimulus. Yet he did so while convincing investors that the Fed would continue to bolster the economy indefinitely. Wall Street roared its approval.
The Fed said in a statement after its policy meeting ended Wednesday that it will trim its US$85 billion a month in bond purchases by US$10 billion starting in January. Bernanke said the Fed expects to make “similar moderate'' cuts in its purchases if economic gains continue.
At the same time, the Fed strengthened its commitment to record-low short-term rates. It said for the first time that it plans to hold its key short-term rate near zero “well past'' the time when unemployment falls below 6.5 percent. Unemployment is now 7 percent.
The Fed's bond purchases have been intended to drive down long-term borrowing rates by increasing demand for the bonds. The prospect of a lower pace of purchases could mean higher loans rates over time.
Nevertheless, investors seemed elated.
The Dow Jones industrial average soared nearly 300 points. Bond prices fluctuated, but by late afternoon the yield on the 10-year Treasury note had barely moved. It inched up to 2.89 percent from 2.88 percent.
“We're really at a point where we're getting to the self sustaining recovery that the Fed has been talking about,'' Scott Anderson, chief economist of Bank of the West. “It really seems like that's going to come together in 2014.''
The Fed's move “eliminates the uncertainty as to whether or when the Fed will taper and will give markets the opportunity to focus on what really matters, which is the economic outlook,'' said Roberto Perli, a former Fed economist who is now head of monetary policy research at Cornerstone Macro.
In updated economic forecasts Wednesday, the Fed predicted that unemployment would fall a bit further over the next two years than it thought in September. And it expects inflation to remain below the target level.
The Fed expects the unemployment rate to dip as low as 6.3 percent next year and 5.8 percent in 2015. Unemployment has fallen faster this year than policymakers had predicted.
And Fed policymakers predict that their preferred inflation index will not reach its target of 2 percent until the end of 2015 at the earliest. For the 12 months ending in October, the inflation index is up just 0.7 percent.
The Fed worries about very low inflation because it can lead people and businesses to delay purchases. Extremely low inflation also makes it costlier to repay loans.
In its statement, the Fed says it will reduce its purchases of mortgage- bonds and Treasury bonds each by US$5 billion. Beginning in January, it will buy US$35 billion in mortgage bonds each month and US$40 billion in Treasurys.
The Fed's actions were approved on a 9-1 vote. The only member to object was Eric Rosengren, president of the Federal Reserve Bank of Boston. He called the move premature because unemployment remains high and inflation extremely low.