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Federal Reserve likely to repeat low rate pledge

NEW YORK (Reuters) - The Federal Reserve, at a meeting this week, will likely close out the year by repeating a pledge to keep interest rates extraordinarily low for an extended period even as it nods to signs of economic healing.

The central bank’s policy-setting meeting on Tuesday and Wednesday will mark a year since the Fed cut benchmark interest rates to near zero to combat the worst economic crisis since the Great Depression.

A year later, the economic picture has vastly improved and the recovery is gaining strength, no doubt bringing closer the day the Fed starts to inch away from its supportive policies.

Policy-makers, however, have continued to point to still strained credit markets and high unemployment as reasons the economy will crawl rather than bounce back to health.

“When the Fed looks at the economic backdrop, they’re looking at the level of economic activity, not just the most recent numbers and we’re still at 10 percent unemployment,” said Julie Coronado, senior U.S. economist at BNP Paribas in New York. “We’re still a long, long way from normal.”

A Reuters survey of economists released last week showed they do not expect the Fed to start raising interest rates until the fourth quarter of 2010.

Financial markets will dissect the Fed’s policy statement, due around 2:15 p.m. EST on Wednesday, for clues on the central bank’s future policy course.

“The statement will probably look like the previous one ... I think the core of the committee is still more worried about the recovery solidifying,” said Mark Gertler, a professor at New York University.

The Fed could nod to a November U.S. jobs report that showed the pace of job losses braking sharply, but Gertler said “that is not enough to lead to any dramatic changes in the policy outlook.

Still, the topic of when to start signaling a policy shift seems certain to be on the table.

“There is definitely ... a significant upside risk here that we will have a stronger recovery than what the Fed and what the consensus was expecting,” Torsten Slock, a senior economist at Deutsche Bank in New York, said on Friday.

Federal Reserve Chairman Ben Bernanke testifies at his Senate Banking, Housing and Urban Affairs Committee hearing on his nomination to continue as Chairman of the Board of Governors, on Capitol Hill in Washington, December 3, 2009. REUTERS/Jason Reed

“Things are moving so much in the right direction that there must be some debate about this issue.”

ONE MONTH DOESN’T MAKE A TREND

The government’s monthly report on employment, released on December 4, showed the economy lost far fewer jobs than expected last month, while the jobless rate unexpectedly slipped.

Since then, reports have shown unexpected resilience in consumer spending and the first signs businesses are starting to build up inventories, which should support production.

But in recent remarks central bank officials have signaled a go-slow approach on policy.

Just hours after the jobs report, Philadelphia Federal Reserve Bank President Charles Plosser, one of the Fed’s most vocal anti-inflation hawks, emphasized that one month does not a trend make.

And last Monday, Fed Chairman Ben Bernanke and New York Fed President William Dudley said economic conditions still warrant exceptionally low interest rates for an extended period.

“They may sound a little bit better on growth, and make some indirect reference to improvement in the labor market in the statement,” said JPMorgan Chase economist Michael Feroli. “But we think the forward-looking language will be unchanged and the inflation language will be unchanged.”

After its last meeting on November 3-4, the Fed said economic slack was curbing price pressures and it expected inflation to remain “subdued for some time.”

Apart from cutting rates to near zero last year, the Fed has pumped more than $1 trillion into the economy by buying mortgage-related securities and U.S. Treasury debt.

The committee may discuss whether it would make sense to keep its $1.25 trillion mortgage-backed securities purchase program alive past its March expiry date. St. Louis Fed chief James Bullard has argued that keeping it running at a low level would give the Fed added policy flexibility.

Bill Gross, who runs Pacific Investment Management Co, or Pimco, the world’s biggest bond fund, said on Wednesday that he was not entirely convinced that the Fed’s extraordinary programs -- or quantitative easing policies -- will end on schedule.

“There are so many uncertainties and I think the Fed recognizes that, and not just from the standpoint of the policy rate but the standpoint of quantitative easing,” Gross told the Reuters Investment Outlook Summit.

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