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Fed likely to stay course as Cyprus roils markets

Federal Reserve Chairman Ben Bernanke testifies February 26, 2013 in Washington
Federal Reserve Chairman Ben Bernanke testifies before the Senate Banking, Housing and Urban Affairs Committee after the release of The Semiannual Monetary Policy Report to the Congress February 26, 2013 in Washington. The Fed looked set to keep its loose

The Federal Reserve looked set to keep its loose monetary policy in place this week as a shock Cyprus plan to seize bank deposits stoked fears of a reigniting eurozone banking crisis.

The Fed was widely expected to announce Wednesday, after a two-day policy meeting, that it will continue to pump $85 billion a month into bond purchases to support the US economy.

The Federal Open Market Committee also was all but certain to reiterate that its record-low interest rate, between zero and 0.25 percent, would remain until the labor market improves "substantially" in a context of price stability around 2.0 percent.

Despite a string of encouraging data, particularly in jobs growth and the housing market, the economy remains too tepid for the FOMC policy makers to change course now, analysts say.

Gross domestic product growth was merely 0.1 percent in the fourth quarter and although there are signs it has picked up, momentum was "modest to moderate" recently, according to the latest Fed Beige Book.

Nevertheless, the minutes of the January FOMC meeting revealed some participants were concerned about the costs and the risks of the accommodative monetary policy, saying it could spark a jump in inflation.

Fed watchers were expected to pore over the FOMC statement for any sign the Fed may be looking more closely at winding down the stimulus.

"Since core inflation remains pretty much glued to the 2 percent mark, I don't think inflation will be a factor in the Fed's deliberation except perhaps among the well-known hawks on the FOMC," said Robert Brusca of FAO Economics.

The FOMC meeting that opens Tuesday is the first since the government's massive across-the-board spending cuts kicked in on March 1.

The impact of the so-called "sequester" spending cuts was not immediately clear, but they could lead the FOMC to revise downward their projections for 2013 growth when they release new forecasts Wednesday, Barclays analysts said.

Economists estimate that the fully implemented cuts -- slashing $85 billion over seven months -- will drain about a 0.5 percentage point from US growth this year.

With unemployment still a high 7.7 percent, the cuts could also cost some 750,000 jobs, the White House estimates. Fed chairman Ben Bernanke has repeatedly defended the central bank's accommodative policy as necessary as long as unemployment remains high.

Meanwhile the fresh Cyprus turmoil could keep the FOMC focused on the ongoing risks of the European financial crisis to the US economy.

Cyprus announced Saturday it would collect a one-time tax on bank deposits to help pay for a bailout sponsored by the European Union, the European Central Bank and the International Monetary Fund.

The bailout decision sparked global market turmoil and widespread fears of contagion and bank runs.

"It is a development that should lead participants to think the Fed is certainly going to stay on its accommodative policy course," said Patrick O'Hare of Briefing.com.

Chris Low of FTN Financial said that Bernanke would likely get questions about Europe in his post-FOMC news conference Wednesday.

"We are confident he will be ready. The Fed has never stopped worrying about Europe, even as US investors turned their focus elsewhere," Low said.

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