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Fed keeps rates steady, announces it will start reducing balance sheet in October

Federal Reserve chairwoman Janet Yellen
Federal Reserve chairwoman Janet Yellen

The Federal Open Market Committee said Wednesday it will begin reducing its $4.5 trillion balance sheet in October.

The committee also maintained the federal funds rate at a 1% to 1.25% range, stating that it expects inflation on a 12-month basis should remain below 2% in the near term and around 2% in the medium term despite higher prices for gasoline and other items following the impact of Hurricanes Harvey and Irma.

In the committee's statement, it said it will initiate its balance-sheet normalization program by rolling over "at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing during each calendar month that exceeds $6 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve's holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $4 billion. Small deviations from these amounts for operational reasons are acceptable."

"This step reflects rising confidence that the recovery is sufficiently durable to withstand a slow withdrawal of emergency policy measures, a full 10 years after the financial crisis struck," said James McCann, senior global economist at Aberdeen Standard Investments, in an emailed statement.

The economy expanded at a 2.1% annual rate in the first half — in line with the pace during this expansion — and U.S. government 10-year notes yield about 2.24%, down from 2.45% at the start of the year. The Fed's preferred price gauge rose 1.4% in July from a year earlier.

"The labor market has continued to strengthen" and economic activity "has been rising moderately so far this year," the Fed statement said. The FOMC repeated language saying "near-term risks to the economic outlook appear roughly balanced."

The decision to leave the target range for the federal funds rate unchanged and begin the balance-sheet runoff in October was unanimous. The Fed reiterated that interest rates are likely to rise at a "gradual" pace, though updated forecasts indicated that officials see the path as less steep than before.

In their new set of projections, Fed officials estimated three quarter-point rate hikes would be appropriate next year — the same number they saw in June — based on the median in the so-called dot plot of interest-rate forecasts.

"We suspect that the Fed will struggle to deliver a full 100 (basis points) in interest rate hikes by the end of next year," Mr. McCann said. "Instead we expect three moves, with inflation likely to remain frustratingly sluggish."

Bloomberg contributed to this story.