Fed holds steady after sobering GDP report

The Federal Reserve opted to stay the course with its existing easy money policy, just hours after the government reported the economy shrank at the end of 2012.

The Federal Open Market Committee (FOMC) announced Wednesday that it would keep interest rates near zero, and continue the existing practice of of buying $85 billion of bonds a month in further efforts to lower borrowing costs and support the economy.

In its policy statement, the FOMC said that economic growth had "paused" in recent months, but blamed the slowdown largely on disruptions from Hurricane Sandy and other "transitory factors." The Fed made no direct reference to the ongoing fiscal standoffs in Washington, and what impact that may have on the recovery.

Employment kept growing at a "moderate pace," even as unemployment remained elevated.

Even when temporary disruptions have abated, the Fed still expects the economy simply to grow at a "moderate pace" with the jobless rate gradually falling. Furthermore, Fed officials continue to see "downside risks" to the economy.

The central bank announcement came hours after the Commerce Department reported the economy surprisingly shrank in the fourth quarter of 2012. The initial estimate of the nation's gross domestic product (GDP) found it dwindled by 0.1 percent in the last three months of the year, as spending by the federal government and the defense industry declined steeply as the "fiscal cliff" began to approach. 

Congress eventually struck a deal to prevent most of the tax hikes that came with the cliff, and delayed for two months the automatic sequester spending cuts.

In its latest statement, the Fed agreed to continue purchasing $40 billion of mortgage bonds a month, supplemented with another $45 billion of Treasury bonds, which make up its latest round of "quantitative easing." It also reiterated that its "highly accommodative" policies would remain in place until either the unemployment rate dipped to 6.5 percent (it currently sits at 7.8 percent) or inflation climbed above two percent.

It also added that if the labor market did not improve substantially, the Fed would be prepared to continue the purchases and employ other "policy tools as appropriate."

Minutes from the Fed's last meeting in December indicated that several FOMC member believed the Fed would have to back off from its bond purchases sometime "well before" the end of 2013, while others backed a longer run of purchases. The latest policy statement does not weigh in on the timing issue, nor whether the disappointing GDP report had any impact on it.

All but one FOMC member voted for maintaining existing policy. Esther George, president of the Federal Reserve Bank of Kansas City, dissented from the statement, citing inflation concerns about the Fed's current policy.