By Kate Davidson 

WASHINGTON -- The Federal Reserve signaled Friday it is unperturbed by the volatility in financial markets earlier this month and remains on track to raise rates gradually this year.

In its semiannual monetary policy report to Congress released Friday, the central bank said it still sees equity prices as elevated despite the market selloff in early February, but noted that "overall vulnerabilities in the U.S. financial system remain moderate on balance."

Fed Chairman Jerome Powell is set to testify on the report Tuesday before a House committee, his first appearance on Capitol Hill since he was sworn in as the new leader of the U.S. central bank this month. He is scheduled to testify before the Senate Banking Committee on Thursday.

Stock price pressures edged up from already elevated levels over the second half of 2017, the Fed said in Friday's report, and are higher than would be expected given the current level of longer-term Treasury yields.

The Fed attributed the increase in part to growing anticipation of the boost to earnings from the $1.5 trillion tax cut enacted at the end of 2017. That helped boost price-to-earnings ratios close to their highest levels outside of the late 1990s through January, before they dropped back in early February, the report said.

The market turbulence earlier this month was triggered in part by stronger-than-expected wage growth that suggested inflation may finally be turning up after years of hovering below the Fed's 2% target. That fueled concerns the Fed might move to raise rates more quickly than previously expected.

In its report Friday, however, the Fed said it continues to view wage gains as moderate, "likely held down in part by the weak pace of productivity growth in recent years."

The Fed's policy committee voted in January to keep its benchmark federal-funds rate at a range between 1.25% and 1.5%. Officials in December penciled in three rate increases for 2018, though many analysts now forecast four Fed rate increases this year due to strengthening economic momentum.

Friday's report largely echoed the minutes from the Fed's January policy meeting released Wednesday.

Policy makers signaled growing confidence in the economy when they last met, according to minutes from the Jan. 30-31 session, and several believed the economy was set to grow even faster than when they boosted their growth projections in December. Some officials also appeared more certain inflation would return to their 2% target over the coming years, after years of lagging behind it.

"A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate," the minutes said.

Since Fed officials met in January, Congress approved a two-year, $300 billion increase in government spending. The spending deal, as well as the tax cut, "will likely provide a moderate boost to (gross domestic product) growth this year," the Fed said in Friday's report.

The prospect of faster growth from the fiscal stimulus package has caused some economists to project the Fed will need to raise rates more this year than last year to keep the economy from overheating.

Friday's report noted that monthly readings on core inflation, which excludes volatile food and energy prices, were somewhat higher during the last few months of 2017 than earlier in the year, but measures of longer-run inflation expectations have been generally stable and remain low by historical standards.

Prices rose more than expected for U.S. consumers last month, providing the latest evidence that price pressures are trending up after years of running below the Fed's target. The consumer-price index rose 0.5% in January, driven by broad-based increases in costs like rent, clothing and medical services. A jump in gasoline prices last month helped push prices up 2.1% from a year earlier.

Write to Kate Davidson at kate.davidson@wsj.com

 

(END) Dow Jones Newswires

February 24, 2018 16:51 ET (21:51 GMT)

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