Fed to keep rates same, sets stimulus drawdown

WASHINGTON (AFP) – The US central bank is expected to keep interest rates steady and announce the end of a postfinancial crisis economic stimulus program following a two-day policy meeting on Wednesday.

But markets will be watching carefully to see how the Federal Reserve describes recent trends in inflation, which has been moribund for much of 2017 despite a spike in August amid rising energy prices.

Any comments on inflation could provide a signal about the likelihood third increase in the Fed's benchmark interest rate this year.

The Federal Open Market Committee, which sets monetary policy, also will release the latest quarterly forecasts by voting and nonvoting committee members on the economy and the path of interest rates over the nearand longer-term.

Policymakers have been divided in recent months on the near-term threat of inflation, with some arguing the central bank should be patient before raising rates again. But others are more concerned about financial market risks that could build up if rates remain low too long.

Back-to-back hurricanes that slammed into Texas and Florida – with Hurricane Jose still looming off the eastern US seaboard and Hurricane Maria bearing down on Puerto Rico – also could influence Fed thinking about the timing of the next rate hike, though it is unclear in what direction.

Economists expect the storms will put a dent in thirdquarter economic activity before provoking a short rebound during reconstruction efforts.

But it remains to be seen whether central bankers are more concerned about the temporary slowdown, or will brush it off.

Market odds for at least one rate increase by December were approaching 60 percent by Tuesday afternoon.

Mark Zandi, chief economist at Moody's Analytics, told AFP the Fed should raise rates, because inflation is inevitable given steady growth and falling unemployment.

''In my view, they need to normalize policy,'' he said.

''One of the macroeconomic consequences of Harvey that's still playing out is the cost to energy markets. And that, if anything, will add to inflation.''

Anticipation of this week's monetary policy meeting also saw US bond yields rise in recent days, with investors expecting the Fed will start gradually tightening the money supply.

The Fed has signaled it will begin to reduce the size of its bond holdings, which grew to $4.5 trillion as part of the ''quantitative easing'' program launched in the wake of the 2008 financial crisis after interest rates were cut to zero.

The first step will be to halt the reinvestment of the proceeds of its bond holdings into more securities, rather than outright sales.

As a result, the central bank's balance sheet will shrink over time, drying up a source of liquidity and acting as a small interest rate increase.

Markets have shown no signs of trepidation in advance of the start of the tapering process, which the Fed already announced will proceed at a fixed monthly level that can be adjusted as needed to be either faster or slower.

''The FOMC has transparently telegraphed the start of unwind, so financial markets are expected to continue to take the balance sheet policy change in stride,'' Mickey Levy of Berenberg Capital Markets said in a research note.