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Fed ends special stimulus for economy

Summary

The Federal Reserve announced the end of its bond-buying program, but signaled that it will keep its main lever on interest rates at near-zero levels

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The Federal Reserve announced the end of its bond-buying program to support the economy Wednesday, but signaled no change in plans to keep interest rates at their historically low levels well into 2015.

“On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing,” the Federal Open Market Committee said in its post-meeting monetary policy announcement Wednesday. The statement said the economic outlook has improved since the committee’s previous meeting, referring to “solid job gains and a lower unemployment rate.”

The rate-setting committee announced it will stop buying long-term bonds under its “Quantitative Easing” program, fulfilling a move that it explicitly predicted in its last policy announcement in September.

The Fed began the current round of stimulus in 2012. The move aimed to support the housing market by pumping money into mortgage-backed securities and Treasury bonds. The Fed began winding the program down in December 2013, when it started cutting back — or tapering — the purchases.

On Wednesday, the committee announced it will make the final reduction, cutting monthly purchases from $15 billion to zero and concluding the program. It will continue reinvesting proceeds from mortgage-backed securities and renewing Treasuries when they expire.

The Fed’s main lever on the economy is its control of interest rates, and the FOMC reinforced expectations that there will be no abrupt change in its current policy of ultra-low rates. It has kept the federal funds rate near zero since late 2008 to support recovery in the job market following the financial crisis. The federal funds rate is the rate on short-term loans that banks make to each other to meet reserve requirements.

The statement repeated previous wording calling for near-zero rates to continue for a “considerable time” after the bond purchases end. However, the statement warned that the pace could slow down or speed up, depending on the pace of employment growth and inflation.

Most forecasters expect rate increases to begin in mid- to late-2015, barring an unexpected shift in the speed of the recovery. Fed Chair Janet Yellen has said to expect rate hikes about six months after the end of bond purchases.

Yellen “has made a point of gradualism,” Mesirow Financial economist David Nice said. “I really think the Fed is staying away from surprising the market.”

When the Fed does boost rates — something it hasn’t done since 2006 — credit card holders who carry a balance will feel it. Most credit cards have variable APRs linked to banks’ prime rate, which moves in step with the federal funds rate. So when the Fed boosts its rate, it will ratchet up APRs on existing credit card balances. For a $5,000 balance, each quarter-point increase — the typical minimum hike after a Fed rate meeting — will cost an extra $12.50 a year in interest.

Economic backdrop

The slow pace of recovery from the 2009 recession supports the argument for keeping interest rates low, and indicators in recent weeks have not given the Fed much reason to change course.

Anyone who budgets for groceries and gas welcomes low inflation. But for Fed economists, inflation below 2 percent is a danger sign. Flat prices point to slack in the economy — unused plants and idle workers. In September the Consumer Price Index posted a year-over-year gain of 1.7 percent, below the Fed’s 2 percent target, and economists expect it to stay low.

“With energy prices having slumped and a more uncertain global growth outlook, inflation pressures figure to remain muted over coming months,” Regions Bank Chief Economist Richard Moody wrote in an analysis. The global outlook is clouded by slowing economies in Europe and Asia, which could crimp demand for U.S. exports.

Employment, another important barometer of economic health, notched a modest improvement in September, extending the job market’s gradual march toward full health. The jobless rate fell to 5.9 percent, as the number of unemployed fell by 329,000, the Labor Department said. The Fed has dropped its target for the unemployment rate, saying that it will look at a range of indicators to gauge the job market’s health.

The October FOMC meeting ended a day before the Commerce Department announces third-quarter Gross Domestic Product Thursday. Analysts expect annualized growth of about 3 percent, coming off the second quarter’s strong 4.6 percent rate, according to Bloomberg Markets. The consensus prediction of the GDP price index — the Fed’s favorite yardstick for inflation — is 1.4 percent, which would give the Fed plenty of room to continue holding interest rates low.

See related:What an interest rate increase will cost cardholders

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