UPDATE 1-Fed's Powell urges markets to dial back rate hike expectations

Thu Jun 27, 2013 11:01am EDT

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By Alister Bull

WASHINGTON, June 27 (Reuters) - Financial markets have over-reacted to the Federal Reserve's statements on reducing the pace of bond purchases later this year, and have brought expectations of the first Fed rate hike too far forward, a senior U.S. central banker said on Thursday.

"Market adjustments since May have been larger than would be justified by any reasonable reassessment of the path of policy," Fed Board Governor Jerome Powell said in a speech at the Bipartisan Policy Center, a Washington think-tank.

"To the extent the market is pricing in an increase in the federal funds rate in 2014, that implies a stronger economic performance than is forecast either by most FOMC participants or by private forecasters," he said, referring to the policy-setting Federal Open Market Committee.

The Fed has held rates near zero since late 2008 and is committed to staying on hold until unemployment hits 6.5 percent, provided the outlook for inflation stays under 2.5 percent. The U.S. jobless rate in May was 7.6 percent.

Powell also stressed that any tapering in the pace of asset purchases, which Fed Chairman Ben Bernanke said last week could be scaled back later this year if the economy grows as expected, could be delayed if the economy was weaker than forecast.

"In all likelihood, the current LSAP program will continue for some time," he said, using central bank shorthand for its large scale asset purchases, or so-called quantitative easing.

"I want to emphasize the importance of data over date," he said. "If the performance of the economy is weaker, the Committee may delay before moderating purchases or even increase them. If the economy strengthens faster than the Committee anticipates, the pace of purchases may be moderated somewhat more quickly," he said.

Financial markets have been rocked since Bernanke's remarks, which surprised some investors and unleashed a week of violent volatility in global financial markets.

Powell said that some of this disturbance was probably unavoidable, given the delicate task of communicating evolving views on the economy and Fed policy. But he also argued that real interest rates remained low by historic standards, while equity valuations looked like they were within normal ranges.

"The first reduction in purchases, when it comes, will be an acknowledgement of the economy's progress and a sign of the Committee's confidence in the path to full recovery," he said.

Powell also echoed Bernanke's reasoning that current weak price pressures were likely transitory and that inflation should rise back toward the Fed's 2 percent long-term goal.

Powell emphasized his confidence that the U.S. economy was healing and that important sectors, notably housing, were contributing to growth while inflation was low.

"Overall trends suggest to me that the housing recovery can continue for many years and become an important contributor to growth," he said.

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