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Fed debates merits of earlier rate hike given U.S. jobs gains

By Jason Lange

WASHINGTON (Reuters) - The U.S. Federal Reserve hinted on Wednesday that a surprisingly strong jobs market recovery could lead it to raise interest rates earlier than it had been anticipating.

At the same time, most Fed officials wanted further evidence before changing their view on when rates should rise, according to the minutes from the central bank's July 29-30 meeting.

"Labor market conditions had moved noticeably closer to those viewed as normal in the longer run," the minutes said, adding that policymakers "generally agreed" the job market was healing faster than they had expected.

The Fed had said in its policy statement following the July meeting that there was "significant" labor market slack, but the minutes showed many members of its policy-setting panel thought this characterization "might have to change before long."

"The committee as a whole has started to shift its stance," said Paul Dales, an economist at Capital Economics in London. "The Fed has moved closer towards raising interest rates."

The central bank has held benchmark rates near zero since December 2008, but has signaled it would likely begin to move them up some time next year.

Yields for 10-year Treasury notes moved higher, while the dollar firmed against the euro and the yen after release of the minutes. Interest rate futures continued to point to a first rate hike in July of next year, although the chances of an earlier move ticked slightly higher.

Most Fed policymakers felt any change in their view on when to start raising rates "would depend on further information on the trajectories of economic activity, the labor market and inflation," the minutes said.

Some officials worried a drop in U.S. gross domestic product in the first quarter might signal the economy was weaker than believed, despite the widely held view the decline was largely due to bad weather and other temporary factors.

And several felt the low level of inflation warranted an easy monetary policy stance.

Most of the debate, however, centered around the amount of slack in the labor market, with many officials pointing to the millions of workers who have been out of work for extended periods or who are unable to find full-time employment.

"It's all about jobs, jobs, jobs - specifically well-paying full-time jobs," said Putri Pascualy, credit strategist for Pacific Alternative Asset Management Company in Irving, California.

PLANNING THE EXIT

The Fed has pledged to keep interest rates near zero for a "considerable" period after it wraps up a bond-buying stimulus program in October.

In a slight shift from the views expressed at the Fed's June policy meeting, the minutes said "most" Fed officials supported re-investing the maturing securities in the central bank's vast portfolio until sometime after its first rate hike. The minutes of the previous meeting said only that "many" supported this approach.

The latest minutes also showed officials had largely agreed on a framework for eventually raising rates, with almost all of them agreeing it would be appropriate to retain the overnight federal funds rate as their key target.

They also want to keep targeting a quarter-percentage point range for the federal funds rate, which is currently at between zero and 0.25 percent.

To establish the upper bound of future target ranges, most policymakers expected to rely on the rate the Fed pays commercial banks on the excess cash they park at the central bank. The bottom of the range would be set at the same rate the bank plans to pay on overnight reverse repurchase operations.

In reverse repos, the Fed borrows funds overnight from banks, large money market mutual funds and others. The tool is designed to mop up excess cash in the financial system which could keep market rates too low if left in circulation.

(Reporting by Jason Lange in Washington; Additional reporting by Michael Connor in New York; Editing by Paul Simao)

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