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Federal Reserve boosts outlook as U.S. recovery picks up speed

Traders work on the floor of the New York Stock Exchange as Ben S. Bernanke, chairman of the U.S. Federal Reserve, speaks on television, Wednesday, June 19, 2013.

Jin Lee/Bloomberg

The world's most important central bank says the U.S. economy is at a historic turning point in the five-year slog to recover from the Great Recession, signalling that an end is in sight for the extraordinary measures taken to head off economic disaster.

In its quarterly forecast, the U.S. Federal Reserve predicts that gathering strength in the economy will push the unemployment rate down to as low as 6.5 per cent – the demarcation point between sluggish and healthy growth – by 2014, a year earlier than previously forecast. And the Fed now forecasts that the economy will expand by 3 per cent or 3.5 per cent in 2014, up slightly from its March forecast.

Lower unemployment would also mark the point at which the Fed has said it would begin to consider raising interest rates, which have been frozen at historically low levels since the financial crisis of 2008 sent the U.S. economy into a tailspin.

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Fed chairman Ben Bernanke pointed to the housing sector – whose implosion helped trigger the recession – as a key source of economic strength.

Mr. Bernanke said the resulting increased household wealth is boosting consumption and consumer sentiment. That is a reversal of the housing sector's wealth-killing effects in the last half-decade, which cost the U.S. economy millions of jobs.

A healthier U.S. economy would also spell good news for Canada, boosting Canadian exports and bolstering business confidence, singled out Wednesday by new Bank of Canada Governor Stephen Poloz as key ingredients in a sturdy rebound.

And the stronger outlook would also be welcomed around the world, because a slow-growing U.S. economy has proved to be a significant drag on global growth.

If the Fed's rosier outlook becomes reality before Congressional midterm elections in 2014, the Republicans will have trouble using President Barack Obama's handling of the economy as a centrepiece of their strategy to grab more seats from the Democrats and pave the way for a run at the White House.

Improving economic conditions in North America are prompting lenders to bump up some commercial and mortgage rates in the U.S. and Canada. And the new forecast could lead the Fed to hike its rock-bottom official rate by 2015. That would put pressure on the Bank of Canada to ratchet up its own benchmark rate just as Prime Minister Stephen Harper's Conservatives are preparing for an election of their own.

The Bank of Canada is watching the Fed carefully, because at some point it will declare its job nearly done as the U.S. economy continues to strengthen.

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"If the Bank of Canada concludes that the Fed has identified something that's going to result in stronger growth and a tighter labour market, [officials] may think it will have a greater impact on growth in Canada," said Paul Ferley, assistant chief economist with Royal Bank of Canada. "In that regard, it could have a bearing on our pace of tightening."

Last December, Fed policy makers tied changes in the benchmark rate to both employment and inflation, vowing to leave the rate in its current range of zero to 0.25 per cent as long as the jobless level stays above 6.5 per cent and the inflation outlook remains tame. U.S. unemployment stood at 7.6 per cent in May.

It was the first time the Fed had selected a specific jobless target. And as Mr. Bernanke, 59, heads toward his expected departure when his current term expires next January, it remains a controversial part of his legacy.

Mr. Bernanke will be remembered best for steering the U.S. through a crippling financial crisis and the worst economic slump since the Great Depression, with a mix of bold policies that took the Fed into places neither it nor any other central bank had ventured before. Now comes the hard part – exiting from years of easy money without sending the economy into reverse. Mr. Bernanke's innovations were many: setting a target for the unemployment rate, paying interest on excess bank reserves, and most dramatic of all, three rounds of massive monetary intervention, called quantitative easing, in which the Fed directly bought bonds and other financial assets to stimulate the economy.

Fed officials have stressed that there will be a time lag between the end of easing and a shift toward tighter monetary policy and higher interest rates. The bank's revised forecasts show that 15 of the 19 Fed board members think the first rate hike since the financial collapse of 2008 will not occur before mid-2015.

A successful unwinding, coupled with low inflation and still low borrowing charges, would be a political gift to theWhite House and the Democrats. "Whether they deserve it or not, presidents get credit for good times and blame for the bad," said Douglas Holtz-Eakin, president of the American Action Forum, a conservative think tank in Washington, and a former economic adviser to Republican presidential candidate John McCain.

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"The Democrats have been waiting for the economy to stop being an anchor on their electoral chances for some time. It's a bad-news story they've had to explain away for a number of years now."

On the other hand, Mr. Holtz-Eakin said, if the Fed turns out to be badly wrong, and the economy stalls, "it's going to be an unforgiving atmosphere for Democrats" in the 2014 elections.

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