Fed Sees Improving Economy, Job Market; September Rate Hike in View

By Howard Schneider and Michael Flaherty

WASHINGTON, July 29 (Reuters) - The U.S. economy and job market continue to strengthen, the Federal Reserve said on Wednesday, leaving the door open for a possible interest rate hike when central bank policymakers next meet in September.

Following a two-day policy meeting, Fed officials said they felt the economy had overcome a first-quarter slowdown and was "expanding moderately" despite a downturn in the energy sector and headwinds from overseas.

The central bank nodded in particular to "solid job gains" in recent months.

"On balance, a range of labor market indicators suggest that underutilization of labor resources has diminished since early this year," the Fed said in a policy statement that kept rates unchanged.

That language marks an upgrade in its view of labor conditions since its June meeting, when it said labor slack had "diminished somewhat."

The statement may strengthen expectations of a rate hike at the Fed's September meeting. The central bank has kept rates at a near-zero level since December 2008 as part of its effort to spur the recovery from the 2007-2009 financial crisis.

An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst

However, the Fed didn't give a clear signal on its rate plan. Instead, it said it wanted to see "some further improvement in the labor market," and gain more confidence that low inflation will rise to its 2 percent medium-term target.

The policy statement also retained language saying that risks are "nearly balanced," suggesting the Fed is still more concerned about a new economic downturn rather than of rapidly rising inflation.

Central bank officials and market analysts have been waiting to see if weak growth in the first part of the year signaled the beginning of the end of an economic expansion, or merely a pause.

The verdict now seems firm.

Most economists forecast that U.S. economic growth will pick up after a lackluster first half and that the Fed will begin its monetary tightening in September, according to a Reuters poll published last week.

And Wall Street's top banks still target September as the most likely time for the Fed to begin its monetary tightening, according to another Reuters poll published earlier this month.

Though inflation remains weak, the statement portrayed an economy that continues to tighten, with a 5.3 percent unemployment rate and steady job creation.

With no meeting scheduled in August, the Fed will have two months of data to analyze before deciding whether to hike rates for the first time since 2006.

There were no dissents.

(Reporting by Howard Schneider; Editing by Paul Simao)

((howard.schneider@thomsonreuters.com;))