Fed holds the line on bond buying

The US Federal Reserve sprung a surprise on markets by keeping its asset purchases steady at $85bn a month as chairman Ben Bernanke backed away from the guidance he gave in June.

The Fed cut its growth forecast and confounded expectations that it would start to slow its third round of quantitative easing as the rate-setting Federal Open Market Committee said it would “await more ­evidence that progress will be sustained before adjusting the pace of its purchases”.

The decision suggests the Fed was alarmed by the sharp rise in long-term interest rates that followed its June announcement of a likely scenario for tapering its QE3 programme and wanted to push back against markets, and by the prospect of a big fiscal showdown in the US Congress in the coming weeks.

“The tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market,” said the FOMC in its statement.

Investors reacted by pushing the S&P 500 up 1.2 per cent to a record high of 1,725.52, while gold rose 3 per cent to $1,362.25 per troy ounce, and the yield on 10-year Treasury notes dropped to just below 2.70 per cent.

“This is not what we expected however it is, from the Fed’s point of view, understandable,” said Dan Greenhaus, chief global strategist at BTIG.

Mr Bernanke sent mixed signals about whether the Fed still expects a taper this year. On one hand he said that the delay is a “precautionary step” and the intention is “to wait a bit longer” for confirming evidence of growth; but on the other, he said that even with such data, a taper would come “possibly later this year”.

“Asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases,” the FOMC said.

The Fed will continue to purchase mortgage-backed securities at a pace of $40bn a month and Treasury securities at a pace of $45bn a month. It made no change to its 6.5 per cent unemployment rate threshold for a rise in interest rates. The vote for the decision was 9-1 in favour.

One factor may have been a downgrade to the FOMC’s growth forecasts for this year and next. The Fed now expects growth of 2.2 per cent in 2013 compared with a June forecast of 2.5 per cent; and 2014 growth of 3 per cent compared with a June forecast of 3.3 per cent.

In a strong signal that the Fed intends to keep rates low for a long time into the economic recovery, the FOMC estimated that interest rates would be 1 per cent at the end of 2015 and 2 per cent at the end of 2016.

The interest rate forecast for 2016 is low even though the Fed expects the economy to be close to full employment by then. It predicted an unemployment rate of 5.7 per cent at the end of 2016 compared with a long-run equilibrium of 5.5 per cent.

Mr Bernanke said that rates would rise slowly even after 2016. “I think you would expect to see the rates would gradually rise for the two or three years after 2016 and ultimately get to 4 per cent,” he said.

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