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WASHINGTON (Reuters) - A lull in global market turmoil allowed the U.S. Federal Reserve to raise interest rates with a clear conscience in December, but policymakers across the spectrum now acknowledge the economic landscape may have shifted beneath their feet since the move.
It is too early to declare the first rate hike in nearly a decade a mistake, they say, or to fear the U.S. central bank will be forced, like the European Central Bank and others, to retreat before the current tightening cycle is complete.
But that process could take years, given the gradual pace of rate hikes the Fed has projected, and cracks may already be appearing.
Global stock markets continued their 2016 nosedive on Friday as investors braced for a third straight week of losses. Following sharp drops in Europe and Asia, major U.S. stock indexes were down more than 3 percent in midday trading in New York.
While Fed policymakers do not put a lot of weight on equity market moves, they are concerned the loss of investment wealth, unless it proves temporary, could curb spending and confidence among U.S. households and businesses. The Fed forecast that underpinned last month's rate hike leans heavily on domestic consumption to keep the economy growing and offset what the central bank acknowledged is a risky global environment.
U.S. data on Friday also showed a broad decline in retail sales, even after factoring out the downward pull of cheaper gas and prices of some other volatile goods.
A global equities selloff sparked by a sharp drop on China's stock market caused the Fed to delay a widely expected rate hike at its September policy meeting, and officials once again are closely watching volatility on financial markets.
"It is a matter of how long it lasts," Atlanta Federal Reserve Bank President Dennis Lockhart said this week. "I don't want to put a specific number on it, but a matter of several weeks can begin to have an influence on the real economy."
Low oil prices - they tumbled on Friday below the psychologically important $30 a barrel level- are keeping a lid on consumer prices and raising concerns that inflation will remain stalled below the Fed's 2 percent target.
Central bank data on Friday also painted a gloomy picture of the manufacturing sector, which has been hard hit by the impact of a strong U.S. dollar and deep spending cuts by oil and gas companies.
Industrial output fell 0.4 percent in December, the third straight monthly decline, while capacity utilization fell 0.4 percentage points to 76.5 percent.
Even last month's strong jobs report, which showed a surge in payrolls to just below 300,000 in December and sharply higher revisions for the previous two months, comes with a caveat.
While the pace of job creation played a large role in the Fed's decision to raise rates, officials also expect it to slow with the economy so close to full employment. The U.S. unemployment rate is at a 7-1/2-year low of 5 percent.
They have already tried to shape expectations around monthly job gains of perhaps 100,000 as being enough to accommodate population growth and continue pulling some sidelined workers back into the labor market.
The changing outlook has caused investors to shift their expectations for the timing of the next rate hike from April to June, a pace about half as fast as that projected by Fed officials in December.
From dovish policymakers who warned last year of the global risks to the inflation hawks who argued for earlier rate hikes, Fed officials agree the weeks since their historic policy shift have not been kind.
"I don't disagree with our critics that there were risks from lifting off in December versus waiting a little longer," New York Fed President William Dudley said in remarks on Monday.
He said, however, he still believes the December decision was correct because "these risks were manageable ... Downside forecast errors are certainly possible, but the U.S. economy appears to be on sufficiently sound footing to withstand downside shocks better than was the case a few years ago."
Although equity markets are looking sickly, U.S. bond market yield curves are far from signaling major recession concerns,
St. Louis Fed President James Bullard sees no merit in Fed hand-wringing over the rate hike, telling reporters in Memphis this week: "I think you should get out of the 'mistake business.'"
"You look at the information you have at the time and made the best decision that you can ... You go forward, of course you could get shocks. Then you look at a new decision on the new day and you chart a new course. That whole sequence could be viewed as exactly right."
Reporting by Howard Schneider; Editing by Paul Simao