Federal Reserve lowers economic forecast but continues to cut bond purchases


U.S. Federal Reserve Chair Janet Yellen holds a news conference after the two-day Federal Open Market Committee meeting at the Federal Reserve in Washington. (Reuters/Jonathan Ernst)

The Federal Reserve on Wednesday downgraded its outlook for the U.S. economy this year but forged ahead with the phaseout of its signature stimulus program.

The nation’s central bank lowered its forecast for growth this year to between 2.1 percent and 2.3 percent, down from its previous prediction of nearly 3 percent. The mediocre expansion is primarily the result of a disastrous winter in which the economy actually shrank by 1 percent. Though the recovery has picked up speed since then, it is unlikely to make up all of its lost ground. The Fed kept its estimate of the rate of growth next year unchanged at 3 percent to 3.2 percent.

"Economic activity is rebounding in the current quarter and will continue to expand at a moderate pace thereafter," Fed Chair Janet Yellen said in a press conference Wednesday after the central bank's regular policy-setting meeting in Washington.

That description of the nation's economic situation is stronger than the one given after the Fed’s last meeting in April – and enough to convince officials to continue scaling back support for the economy. The Fed has bought more than $1 trillion in long-term bonds over the past year and a half in an effort to bring down long-term interest rates. Since January, it has slowly reduced its purchases at every meeting. The Fed voted unanimously to cut them by another $10 billion on Wednesday, bringing the amount of monthly purchases to $35 billion.

In its statement, the central bank said that "underlying strength in the broader economy" would support continued improvements in the labor market. The economy has added at least 200,000 jobs a month for the past four months, and the unemployment rate has dropped to 6.3 percent, a full percentage point lower than it was last summer. Some Fed officials believe the risk of significant inflation rises dramatically once the jobless rate hits 6 percent.

Inflation has ticked up recently, though it remains below the Fed's target. The government's tally of price changes rose by 2.1 percent in May from a year ago -- about double the rate of growth over the fall. The Fed's preferred measure of inflation stands at about 1 percent, compared to the central bank's 2 percent target. But it, too, has been rising.

That means the central bank is running out of wiggle room in how long it can keep goosing the economy. Officials reiterated Wednesday that they would likely keep interest rates at zero for a "considerable time" after they wrap up their bond purchases later this year. Yellen previously characterized the language as meaning about six months, putting the first rate hike roughly in the middle of next year. But on Wednesday, she emphasized that the central bank is not locked into a date.

"There is no mechanical formula whatsoever for what a considerable time means," Yellen said. "The answer as to what it means is: It depends."

But even as the Fed began preparing markets and the public for an interest rate increase, it has tried to offer assurance that the road back up will be smooth and predictable. A chart of where officials predict rates will be in coming years -- known as “dot plots” -- shows that 11 of the Fed’s 16 top officials believe rates will be below the historical norm of 4 percent.

That's a sharp increase from the six officials who supported that idea in the spring. The shift suggests that the Fed believes the economy’s potential is not as great as it once was. In its statement, the Fed repeated guidance stating that rates will likely remain below the normal level even after employment and inflation have hit its target.

“When the Committee decides to begin to remove policy accommodation, it will take a balanced approach,” the statement said.

Yellen said that the Fed will likely revise the official principles guiding its exit from the extraordinary support for the economy later this year. She expressed support for former Fed Chairman Ben S. Bernanke's suggestion that the central bank will not need to sell its massive portfolio of mortgage-backed securities.

However, Yellen gave no indication of when the Fed might end the reinvestments in long-term bonds that keep its balance sheet from running off as securities mature. Reinvestments have averaged about $16 billion a month for the past four months. New York Fed President William Dudley has expressed concern that stopping those purchases could be misinterpreted by the markets as a sign that the first rate hike is imminent and argued to keep them going until after that moment has passed. But others, such as Kansas City Fed President Esther George, are uncomfortable with the size of the central bank’s $4 trillion balance sheet and are pushing to start shrinking it soon.

The Fed also marked a new chapter this week as several fresh faces gathered around the central bank’s mahogany conference table to deliberate on monetary policy. The meeting was the first for Vice Chairman Stanley Fischer and Fed governor Lael Brainard, both of whom were sworn into those positions earlier this week. In addition, Loretta Mester joined as head of the Cleveland Fed and has a voting seat on the policy-setting committee this year.

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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