Fed stands by stimulus - sees stronger US economy

The Federal Reserve said overnight that the US economy has strengthened after pausing late last year but still needs the Fed's extraordinary support to help lower high unemployment.

In a statement after a two-day meeting, the Fed stood by its plan to keep short-term rates at record lows at least until unemployment falls to 6.5 per cent, as long as the inflation outlook remains mild. And it says it will continue buying $US85 billion a month in bonds indefinitely to keep long-term borrowing costs down.

The unemployment rate fell to a four-year low of 7.7 per cent in February, among many signs of a healthier economy.

The Fed notes in its statement that the job market has improved, consumer spending and business investment have increased and the housing market has strengthened.

Still, its latest economic forecast, also released overnight, maintains that unemployment won't reach 6.5 per cent until 2015.

The Fed also cautioned that government spending cuts and tax increases could slow the economy. It projects growth won't exceed 2.8 per cent this year, slightly lower than its December forecast of 3 per cent.

A total of 13 Fed officials still believe the first rate hike will not occur until 2015, the same number as in December. One Fed official projects the first boost in the short-term lending rate will not occur until 2016.

The statement was approved on an 11-1 vote. Esther George, president of the Kansas City regional Fed bank, dissented for a second straight meeting. She reiterated her concerns that the Fed's aggressive stimulus could heighten the risk of inflation and financial instability.

The economy slowed to an annual growth rate of just 0.1 per cent in the October-December quarter, a near-stall that was due mainly to temporary factors that have largely faded. Economists think growth has rebounded in the January-March quarter to an annual rate around 2 per cent or more. The most recent data support that view.

Americans spent more at retailers in February despite higher Social Security taxes that shrank most workers' paychecks. Manufacturing gained solidly in February. And employers have gone on a four-month hiring spree, adding an average of 205,000 jobs a month. In February, the unemployment rate, though still high, reached its lowest point since December 2008.

One reason for the Fed's reluctance to reduce its stimulus is the history of the past three years. In each of the three, economic prospects looked promising as the year began. Yet in each case, the economy stumbled.

In 2010, US growth was hurt by turmoil from Europe's debt crisis. In 2011, a spike in gas prices and supply disruptions caused by Japan's earthquake and tsunami dampened growth. And in 2012, higher gas prices cut into consumer spending.

Though the economy has brightened this year, it still faces threats, including across-the-board government spending cuts that took effect March 1 and are expected to trigger furloughs and layoffs. Those spending cuts, along with the Social Security tax increase and higher taxes on top earners, are expected to cut growth in half this year, according to the Congressional Budget Office. The CBO predicts that the drag will slow growth by 1.5 percentage points, to 1.5 per cent.

-AP