Fed says recovery 'gaining traction'

The Federal Reserve said this evening the US recovery was gaining traction and rising inflation pressures will probably prove transitory as it stuck to its program of extraordinary monetary support.

The Fed's widely expected decision to stay on schedule with its $600 billion bond-buying plan comes on a day of steep selling on stock markets around the world as investors assessed the devastating toll of Japan's earthquake and tsunami, and fretted over the possibility of a broader nuclear crisis.

The heightened uncertainty reinforced the case for keeping policy steady, despite a marked upgrade of the US central bank's view of the economy and the job market.

"The economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually," it said in a statement.

That was a much rosier assessment than it offer after its last meeting in January, when it said that the recovery was still too weak to significantly bring down unemployment.

US stocks trimmed losses and the dollar held steady against the euro and the yen. Prices for US government debt slipped slightly.

The Fed dedicated an unusually large portion of its statement to inflation concerns surrounding a recent spike in energy and food prices. It said it would monitor inflation and expectations for future prices closely, but said so far, so good.

"Long-term inflation expectations have remained stable, and measures of underlying inflation have been subdued," the Fed said, suggesting that it was in no rush to raise overnight interest rates from their current level near zero. The statement made no direct mention of Japan.

"There isn't anything in here to suggest that the Fed is treating events in Japan as a threat to the overall outlook," said Eric Green, chief economist at TD Securities in New York. "If anything they are looking through this at this point and saying, 'We are very much on track for where we would want to be.'"

The worst earthquake on record for the world's third-largest economy could have substantial ripple effects on the global recovery - as evidenced by a sharp pullback in global equity prices, with Japanese stocks down more than 10 per cent today alone.

Even before the tragedy, US central bankers faced confusing signals. Despite high unemployment, rising energy costs appear to be nudging up the price expectations of US consumers, the first inklings of an inflationary psychology the Fed would like avoid.

Fed officials managed that tension by beefing up their assessment of economic conditions while emphasising just how far the central bank remains from its targets for both inflation and employment.

Since the Fed's last meeting in January, the US economy has continued to show signs of promise. The US unemployment rate has fallen rapidly, down to 8.9 per cent in February from 9.8 per cent in November.

Still, the pace of hiring suggests further progress will be painfully slow for the 8-million-plus Americans who lost their jobs during the economic slump of 2007-2009.

At the same time, higher gasoline costs have created fresh concerns for consumers, with a big hit to confidence this month raising concerns about whether a recent spurt in consumer spending can be sustained.

The US economy expanded at an annual rate of 2.8 per cent in the fourth quarter, a respectable performance but a faster pace will likely be needed to make a further appreciable dent in unemployment.

Some economists thought growth could approach 4 percent this quarter, but have pared back projections, in part because of an unexpected widening in the US trade deficit.

The Fed effectively chopped overnight interest rates down to zero in December 2008 and then turned to buying mortgage and US  Treasury debt to keep long-term borrowing costs low. In all, it has committed to buying $2.3 trillion in debt.

The asset purchases have proven controversial, with domestic critics arguing the Fed is courting future inflation while officials in emerging markets have accused the central bank of trying to boost US exports by devaluing the dollar.

With the economy strengthening, officials are also likely to have had a vigorous debate on how best to eventually tighten policy, but analysts will have to wait until Fed speakers take to the podium again to get a fuller flavor of the discussions.

Reuters