The Federal Reserve kept its easy-money policies intact as markets reeled from a series of global shocks, but it also offered reassuring words about the economic outlook and signaled vigilance on inflation.
The economy is on a "firmer footing," while the labor market is "improving gradually" and household spending and business investment are expanding, the policy-making Federal Open Market Committee said in a statement following its one-day meeting. Cautionary words about the economy from previous statements were pared back. Meanwhile, energy-price increases have put upward pressure on inflation, the FOMC said. It expects this to be transitory but "will pay close attention," it said.
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Fed Chairman Ben Bernanke and his colleagues are moving toward important decisions in the months ahead. The central bank's $600 billion Treasury bond purchase program is scheduled to be completed in June. The program will be an important subject of discussion at the next FOMC meeting in April. Officials will decide whether to let the program run out as planned, as many seem inclined to do. A debate about when and how to exit from their easy-money policies by raising interest rates seems to be taking shape for the second half of the year.
Global turbulence in recent weeks shows how the economic outlook, and thus the outlook for Fed policy, can change quickly. "Concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks," the Fed said in its statement.
Higher oil prices are creating competing problems for the central bank—less purchasing power for consumers and thus the risk of slower growth on the one hand, and more inflation pressure on the other. One problem calls for lowering interest rates and the other calls for raising them.
Commodity-price pressures, Fed officials have found, are becoming uncomfortable to look past, in part because they resonate deeply with the public. Federal Reserve Bank of New York President William Dudley drew skepticism Friday during an appearance in Queens, N.Y., by saying he believed underlying inflation was low despite rising food and energy prices. One member of the audience responded, "When was the last time, sir, you went grocery shopping?"
Despite the rise in oil and food prices—and a recent increase in an indicator of where consumers see prices in the years ahead—the Fed said Tuesday that underlying inflation was "subdued" and repeated that "longer-term inflation expectations have remained stable."
Japan's earthquake and tsunami complicate matters. Financial markets have been severely affected, which could dent consumer and business confidence in Japan and abroad, holding back global economic growth. While the Fed didn't mention Japan's situation directly, the natural disaster has added to the list of potential risks to U.S. growth prospects. Meantime, Europe's sovereign-debt concerns persist.
U.S. stocks recouped some of the day's losses after the Fed upgraded its assessment of the U.S. economy and oil prices retreated from recent highs. Earlier in the day, the Dow Jones Industrial Average dropped nearly 300 points, the biggest intraday loss this year, as global stock markets reacted to fears of a nuclear-power crisis in Japan.
Analysts came away with different interpretations of how far the Fed is from raising interest rates in the U.S.
"When the Fed says the economy is on firmer footing, you can start counting the months if not the weeks until they take their foot off the gas and start to normalize interest rates," said Christopher Rupkey, economist at the Bank of Tokyo-Mitsubishi.
Ethan Harris, head of developed-markets economics research at Bank of America Merrill Lynch Global Research, drew the opposite conclusion. "There is no signal that they are anywhere close to an exit," he said. "I think they're right that serious inflation is a distant concern."
Fed officials voted unanimously to continue with their government bond purchases. They also maintained an important line in their post-meeting statement, saying they expect to keep short-term interest rates close to zero for an "extended period," which means at least several more months.
Since Friday's quake in Japan, financial markets have reset their expectations for when the Fed could increase interest rates. On Thursday, trading in futures markets implied investors saw a 50-50 chance that the Fed would raise its benchmark interest rate—an overnight bank-lending rate called the fed funds rate—to 0.5% by February. Futures prices now imply investors see just a 30% chance that the rate will rise to that level by then.
Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and Luca Di Leo at luca.dileo@dowjones.com
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