Surprise from Fed: No pullback in bond purchases

by MARTIN CRUTSINGER, AP Economics Writer

WASHINGTON (AP) -- In a surprise, the Federal Reserve has decided against reducing its stimulus for the U.S. economy because its outlook for growth has dimmed in the past three months.

The Fed said it will continue to buy $85 billion a month in bonds while it awaits conclusive evidence that the economy is strengthening. The Fed's bond purchases are intended to keep long-term borrowing rates low to boost spending and economic growth.

"Conditions in the job market today are still far from what all of us would like to see," Chairman Ben Bernanke said at a news conference shortly after the statement was released.

Stocks spiked after the Fed released the statement at the end of its two-day policy meeting. The Standard & Poor's 500 index and Dow Jones industrial average jumped to record highs. The Dow was up more than 100 points shortly after the statement was released.

In the statement, the Fed said that the economy is growing moderately and that some indicators of the job market have shown improvement. But it noted that rising mortgage rates and government spending cuts are restraining growth.

The Fed also repeated that it plans to keep its key short-term interest rate near zero at least until unemployment falls to 6.5 percent, down from 7.3 percent last month. In the Fed's most recent forecast, unemployment could reach that level as soon as late 2014.

"We're in a slow-growth economy with high unemployment and low inflation," said Greg McBride, senior financial analyst at Bankrate.com. "There's no specific catalyst for the Fed to remove stimulus."

Many thought the Fed would scale back its purchases. But long-term rates on mortgages and some other loans have jumped since May, when Bernanke first said the Fed might slow its bond buys later this year. But Bernanke cautioned that the reduction would hinge on the economy showing continued improvement.

In its statement, the Fed said the rise in interest rates "could slow the pace of improvement in the economy and labor market" if they are sustained.

The Fed also lowered its economic growth forecasts for this year and next year slightly, likely reflecting its concerns about interest rates. It predicts that the economy will grow just 2 percent to 2.3 percent this year, down from its previous forecast in June of 2.3 percent to 2.6 percent growth.

Next year's economic growth will be a barely healthy 3 percent, the Fed predicts.

The Fed's policymakers expect the unemployment rate to fall to between 7.1 percent and 7.3 percent by the end of 2013, slightly below its June forecast of 7.2 percent to 7.3 percent. It predicts that unemployment will fall as low as 6.4 percent next year, down from 6.5 percent in its June forecast.

The Fed's policy statement was approved on a 9-1 vote. Esther George, president of the Federal Reserve Bank of Kansas City, dissented for the sixth time this year. She repeated her concerns that the bond purchases could fuel the risk of inflation and financial instability.

The decision to maintain its stimulus follows reports of sluggish economic growth. Employers slowed hiring this summer, and consumers spent more cautiously.

Super-low rates are credited with helping fuel a housing comeback, support economic growth, drive stocks to record highs and restore the wealth of many Americans. But the average rate on the 30-year mortgage has jumped more than a full percentage point since May and was 4.57 percent last week -- just below the two-year high.

Investors had bid up those loan rates in anticipation that the Fed would reduce its stimulus as early as this month.

John Canally, investment strategist at LPL Financial, suggested that financial markets overreacted in anticipation of reduced bond purchases, thereby driving interest rates sharply higher.

Higher rates "started to impact the real economy, and (the Fed) got a little bit concerned."

The unemployment rate is now 7.3 percent, the lowest since 2008. Yet the rate has dropped in large part because many people have stopped looking for work and are no longer counted as unemployed -- not because hiring has accelerated. Inflation is running below the Fed's 2 percent target.

The Fed meeting took place at a time of uncertainty about who will succeed Bernanke when his term ends in January. On Sunday, Lawrence Summers, who was considered the leading candidate, withdrew from consideration.

Summers' withdrawal followed growing resistance from critics. His exit has opened the door for his chief rival, Janet Yellen, the Fed's vice chair. If chosen by President Barack Obama and confirmed by the Senate, Yellen would become the first woman to lead the Fed.