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Federal Reserve Chair Janet Yellen speaks during a conference at Brown University. The Fed’s policy minutes showed they favour more tightening in monetary policy and a gradual reduction of their balance sheet. Photo: AP

Fed officials see more tightening and favour shrinking US$4.5 trillion balance sheet

Most Federal Reserve officials judged “it would soon be appropriate” to tighten monetary policy again and backed a plan that would gradually shrink their US$4.5 trillion balance sheet.

“Most participants judged that if economic information came in about in line with their expectations it would soon be appropriate for the committee to take another step in removing some policy accommodation,” according to minutes from the Federal Open Market Committee’s May 2-3 gathering released on Wednesday in Washington.

The statement points toward a hike as soon as the Fed’s meeting in mid-June, though FOMC voters added the caveat that “it would be prudent” to wait for evidence that a recent slowdown in economic activity had been transitory.

Officials opted at the May meeting to leave the target range for their benchmark lending rate unchanged at 0.75 per cent to 1 per cent. They have projected three rate increases in 2017, including the hike they made in March.

Investors see a solid chance of a rate move in June, with pricing in federal funds futures indicating nearly an 80 per cent chance of an increase.

Policy makers have also said they would like to start shrinking their bloated balance sheet by year-end, a move that may lift longer-term borrowing costs and dampen growth.

At the May meeting, nearly all officials “expressed a favourable view” of a staff-presented general approach to shrinking the balance sheet that would involve gradually increasing run-off caps every three months. The caps would eventually reach fully phased-in levels, which would then be held in place until the size of the balance sheet was normalised.

Policy makers agreed that they should provide additional details of the plan “soon” and nearly all said it would be appropriate to start the process this year, provided their expected path for rate hikes stays on track.

In their closed-door meeting, officials discussed a brightening global economic picture and viewed recent soft inflation and output data as likely caused by transitory factors.

Growth slowed in the first quarter to an annualised pace of 0.7 per cent, even as unemployment continued to decline. Labour Department data released two days after the meeting showed the jobless rate in April fell to 4.4 per cent, the lowest reading since 2007 and beneath most economists’ estimates of the lowest sustainable level.

Progress toward the Fed’s 2 per cent inflation goal, however, has wavered, which could be a problem for the central bank should that persist. The Fed’s preferred gauge of price pressures fell to 1.8 per cent in March from 2.1 per cent the month before and the core index, which excludes energy and food, dipped to 1.6 per cent.