As Fed meets to set policy, major shifts unlikely

The U.S. Federal Reserve began a two-day meeting on Tuesday that was expected to show central bank officials are becoming more upbeat about the economy, but not enough to tighten monetary policy.

The Fed slashed benchmark interest rates close to zero a year ago to battle a deepening recession. Now that the U.S. economy is growing again, investors are becoming antsy about when the Fed might begin withdrawing the easy money that has kept financial markets buoyant since March.

Officials have said they are leery of pulling the plug too quickly given the weak labor market and tight lending conditions, making it unlikely a statement at the close of their meeting around 2:15 p.m. (1915 GMT) on Wednesday will signal any policy changes.

Nonetheless, their pronouncement should nod to a recent improvement in the economic data, particularly in light of a considerable deceleration in the pace of job losses last month.

They will be more positive in their assessment, said Carey Leahy, senior managing director at Decision Economics.

Even so, analysts suspect the Fed will not yet overturn its commitment to keep rates at an exceptionally low level for an extended period.

Faced with the worst financial crisis in generations, the Fed not only lowered rates close to zero, but also committed to buying over $1.7 trillion in Treasury bonds and mortgage-linked debt, an effort to suppress long-term interest rates and revive the housing market.

In addition, it created an array of unprecedented lending mechanisms to grease the wheels of global capital, which ground to a halt as mistrust between banks reached fever pitch late last year.

The very first step taken by the central bank when the first rumblings of the crisis became apparent in interbank lending markets was to narrow the premium it charges for direct loans it makes to financial institutions.

Policymakers could choose to unwind that emergency step by widening that spread over overnight rates back to its usual 0.5 percentage point gap from the current quarter point, as some media reports have suggested.

On the inflation front, financial markets have earned the Fed some reprieve. Oil prices, which touched $82 a barrel in late October, have since sunk closer to $70. At the same time, the dollar, whose rapid decline was raising concerns within the central bank, has staged a solid rebound.

Still, a report on Tuesday that showed U.S. producer prices surged a surprising 1.8 percent last month strengthened the case of Fed hawks, who argue that the central bank's low rate policy carries long-terms risks.

We may be recovering faster than people think, said William Larkin, portfolio manager at Cabot Money Management.