Fed keeps $85 billion bond buying pace, sees disinflation risk

None of the 54 economists in a July 18-22 Bloomberg News survey said they expected the central bank to alter the pace of purchases today. Fifty% forecast that the Fed will first reduce bond buying at its Sept. 17-18 gathering.

Policy makers concluded their meeting today after a Commerce Department report today showed the world’s largest economy expanded at a 1.7% annual rate in the second quarter, more than economists forecast, as companies accumulated inventories at a faster pace. Growth in the first quarter was revised down to a 1.1% rate.

The gain in second-quarter gross domestic product showed the economy is overcoming the drag created by an increase in the payroll tax that took effect in January as well as across-the- board federal budget cuts known as sequestration, which began in March.

Growth will quicken as the impact from budget cuts wanes, Bernanke said in his congressional testimony. FOMC participants growth of 2.3% to 2.6% this year. Given today’s GDP report, the economy would have to expand 3.2% in the second half to meet the lower end of Fed forecasts.

“We threw a pretty serious body blow to the economy this year in terms of the tax hikes and budget cuts,” said Josh Feinman, the New York-based global chief economist for Deutsche Asset & Wealth Management, which oversees $400 billion. “That’s taken a toll on growth in the first half of the year, and it’s going to have some lingering effects into the second half.”

A Labor Department report in two days may show that employers added 185,000 workers to payrolls in July and the jobless rate fell to 7.5% from 7.6%, according to the median forecasts in a Bloomberg survey of economists.

“There seems to be an increasing perception that the domestic economy is doing quite well,” Andrew Wilkinson, the chief economic strategist at Miller Tabak & Co. in New York, said before the FOMC statement. “That was really played out in payrolls.”

Payrolls have risen an average of 201,830 per month over the past six months. U.S. employers added 195,000 workers in June for a second straight month, the Labor Department said July 5, capping 12 months of advances above 100,000 for the longest such streak since May 2000.

At the same time, the jobless rate remains well above the Fed’s long-term unemployment forecast of 5.2% to 6%. Inflation is also lagging behind the Fed’s 2% goal: consumer prices rose 1% in May from a year earlier, according to an index followed by the Fed.

Borrowing costs have risen on speculation that an improving economy will prompt the Fed to taper bond buying.

The yield on the 10-year Treasury note soared to an almost two-year high of 2.75% on July 8 from 2.19% on June 18, the day before Bernanke said the Fed may consider reducing bond purchases this year if the economy performs in line with the central bank’s forecast. The yield rose yesterday 0.01 percentage point to 2.61%.

U.S. stocks have rallied amid better-than-estimated corporate earnings. The Standard & Poor’s 500 Index advanced 18% this year through yesterday.

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