Fed renews "extended period" low-rate vow

Trader Richard Smartt reacts in the Euro Dollar pit at the Chicago Mercantile Exchange, March 16, 2010.

WASHINGTON (Reuters) - The Federal Reserve renewed its pledge on Tuesday to keep interest rates near zero for an "extended period" even as it sounded more upbeat about jobs.

The central bank's nod to a firmer job market after the deepest recession in decades offered a hint it may be moving closer to dropping its promise to hold borrowing costs at rock bottom levels.

However, it reintroduced a note of caution about the housing sector and repeated its view the economy's recovery would likely be moderate for a time. It also said inflation was likely to remain subdued as it held interbank overnight rates in a zero to 0.25 percent range.

Following the decision, most big banks that deal directly with the Fed forecast a rate hike by year end, likely in the fourth quarter.

"The (Fed's policy) committee ... continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period," the central bank said in a statement.

U.S. stocks added to gains after the decision, while the dollar slipped against the euro and yen, and prices for U.S. government bonds rose. The Dow Jones industrial average and the large-cap Standard & Poor's 500 Index closed at multi-month highs.

"The statement suggests that the doves still have the upper hand," said Paul Dales, an economist for Capital Economics in Toronto. "Admittedly, the tone was more upbeat...but the usual caution is still evident."

For a second consecutive meeting, Kansas City Federal Reserve Bank President Thomas Hoenig dissented, saying the commitment to keep rates exceptionally low for an extended period was no longer warranted.

The Fed said the labor market was "stabilizing," a more optimistic view than expressed after its last meeting in late January, when the policy-setting committee said only that deterioration in the labor market was "abating."

The central bank also said business spending on equipment and software had risen "significantly," also a brighter assessment than the one offered in January.

The central bank reiterated that it intends to wrap up purchases of mortgage-related assets by the end of March, but said it would monitor the economic outlook and financial developments to see if more support is necessary.

As those purchases come to a close, officials voiced heightened concern about the very sector they were meant to assist, saying that new homebuilding activity was "flat at a depressed level."

Interest rates futures markets pared back the implied prospects that the Fed would raise the federal funds rate to 0.5 percent by its meeting in early November to 76 percent from 87 percent before the central bank's decision was announced.

"On the whole, there is nothing that will accelerate or decelerate toward a monetary tightening very late this year," said Jason Pride, director of investment strategy at wealth management firm Glenmede in Philadelphia.

NOT YET PUSHING EXIT DOOR OPEN

The Fed has held the benchmark federal funds rate near zero since December 2008 to bolster the economy and help it through the most severe financial crisis in generations. Last March, it committed to holding rates very low for "an extended period."

The economy resumed growth in the second half of last year, and expanded at a robust 5.9 percent annual clip in the final three months of 2009.

Although the unemployment rate held at a lofty 9.7 percent in February as the economy shed 36,000 jobs, some of the lost jobs were pinned on blizzards that hit much of the nation. Many economists expect payroll growth as early as March.

Gains in manufacturing activity and retail sales have added to evidence the recovery is gaining traction.

The Fed has allowed special lending facilities to close as financial markets have returned to normal after the crisis, and it recently raised the discount rate it charges banks for emergency loans to 0.75 percent from 0.5 percent.

Fed officials stressed the move was in keeping with the settling of financial markets and was not a precursor to efforts to tighten lending conditions.

However, policymakers have begun to spell out steps they anticipate taking to move away from their easy money policies when the recovery gains steam. Officials say the Fed would likely start by pulling back some of more than $1 trillion it pumped into the economy during the crisis before it begins raising rates.

(Additional reporting by David Lawder, Emily Kaiser and Glenn Somerville; Editing by Andrew Hay)