The Federal Reserve has decided to reduce its stimulus for the U.S. economy because the job market has shown steady improvement. The Fed will trim its $85 billion a month in bond purchases by $10 billion starting in January.
The Fed said it could further reduce the pace of its purchases next year if the improvement continues. The shift could lead to higher long-term borrowing rates for individuals and businesses.
At the same time, the Fed strengthened its commitment to record-low short-term rates. It said it plans to hold its key short-term rate near zero “well past” the time when unemployment falls below 6.5 percent. Unemployment is now 7 percent.
Investors responded by sending stock prices surging more than 150 points, or nearly 1 percent. The yield on the 10-year Treasury note was little changed.
The Fed’s reduction to $75 billion a month in bond purchases is a small but significant step. It means Fed policymakers are ready to ease the extraordinary support they’ve provided to the economy since the Great Recession began six years ago.
The move “eliminates the uncertainty as to whether or when the Fed will taper and will give markets the opportunity to focus on what really matters, which is the economic outlook,” said Roberto Perli, a former Fed economist who is now head of monetary policy research at Cornerstone Macro.
But Perli noted that the Fed has not entirely pulled its support for the economy. By still keeping interest rates historically low, the Fed “will continue to remain very supportive of risky assets,” Perli said.
In a policy statement released after its two-day meeting, the Fed says it will reduce its purchases of mortgage- bonds and Treasury bonds each by $5 billion. Beginning in January, it will purchase $35 billion in mortgage bonds each month and $40 billion in Treasurys.
The bond purchases have helped keep long-term interest rates low to encourage more borrowing and spending.
The Fed’s actions were approved on a 9-1 vote. The only member to object was Eric Rosengren, president of the Federal Reserve Bank of Boston. He called the move premature because unemployment remains high and inflation extremely low.
The Fed’s action comes after encouraging reports that show the economy is accelerating.
Hiring has been robust for four straight months. Unemployment is at a five-year low of 7 percent. Factory output is up. Consumers are spending more at retailers. Auto sales haven’t been better since the recession ended 4½ years ago.
What’s more, the stock market is near all-time highs. Inflation remains below the Fed’s target rate. And the House has passed a budget plan that seems likely to avert another government shutdown next year. The Senate is expected to follow suit.
One factor of concern for some members is inflation, which remains historically low. The Fed’s optimal rate is 2 percent. For the 12 months ending in October, consumer inflation as measured by the Fed’s preferred index is just 0.7 percent, well below its target.
But the Fed sees inflation slowly moving toward its target, according to its most recent economic projections that were released Wednesday. The Fed projects inflation would range between 1.4 percent and 1.6 percent next year and could reach the Fed’s target in 2015 at the earliest.
Fed officials still project economic growth of roughly 3 percent next year. But they are slightly more optimistic about unemployment, predicting it could fall as low as 6.3 percent in 2014, down from a low of 6.4 percent forecast in September.