Fed holds rates steady, sees portfolio cuts "relatively soon"

By Jason Lange and Lindsay Dunsmuir

WASHINGTON (Reuters) - The Federal Reserve kept interest rates unchanged on Wednesday and said it expected to start winding down its massive holdings of bonds "relatively soon" in a sign of confidence in the U.S. economy.

The U.S. central bank kept its benchmark lending rate in a target range of 1.00 percent to 1.25 percent and said it was continuing the slow path of monetary tightening that has lifted rates by a percentage point since 2015.

In a statement following a two-day policy meeting, the Fed's rate-setting committee indicated the economy was growing moderately and job gains had been solid.

It also noted that both overall inflation and a measure of underlying price gains had declined - trends which have worried some policymakers - but that it expected the economy to continue strengthening.

"The committee expects to begin implementing its balance sheet normalization program relatively soon," the Fed said, adding that it would follow a plan outlined in June.

U.S. stock prices rose following the decision while yields on U.S. government debt fell. The dollar fell against a basket of currencies.

After pushing rates nearly to zero to fight the 2007-2009 financial crisis and recession, the Fed pumped over $3 trillion into the economy in a bond-buying spree to further reduce rates. Its balance sheet has grown to $4.5 trillion.

The statement cemented expectations the Fed will announce at its next policy meeting in September the start of its balance sheet reduction plan, marking the end of a controversial tool that drew criticism from Republican lawmakers in Congress.

"The Fed all but told the market the balance sheet run-off will start in September," said Brian Jacobsen, an investment strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.

While Fed researchers have concluded the bond buying only modestly boosted the economy, Fed Chair Janet Yellen has said the central bank could use asset purchases again if the economy fell into a deep rut.

Steady job creation in the economy has pushed the U.S. unemployment rate to 4.3 percent, near a 16-year low. Fed policymakers, however, have said labor market strength could eventually push inflation too high.

The Fed had previously signaled it would begin this year to trim its holdings of U.S. Treasury securities and government-backed mortgage debt.

At the same time, a slowdown in inflation has caused jitters among some Fed officials who are concerned inflation has been below the central bank's 2 percent target for five years. The Fed said on Wednesday it would monitor inflation developments closely.

The Fed's preferred measure of underlying inflation dropped to 1.4 percent in May. It was 1.8 percent in February.

No Fed policymakers dissented in Wednesday's decision.

(Reporting by Jason Lange and Lindsay Dunsmuir; Additional reporting by Rodrigo Campos in New York; Editing by Paul Simao)