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The Federal Reserve Building in Washington.

JIM YOU/REUTERS

The U.S. Federal Reserve has ended a bold and controversial chapter in its monetary policy, winding up its two-year, $1.6-trillion (U.S.) asset purchasing program and turning its sights toward its first interest rate increase since 2006.

In its regularly scheduled monetary policy statement, the U.S. central bank's policy-setting Federal Open Market Committee said it would end this month the so-called quantitative easing program known informally as QE3, under which it has been buying bonds and mortgage-backed securities monthly in an effort to ease lending conditions and stimulate economic activity.

At its peak, the Fed was buying $85-billion a month of assets. But since the beginning of this year it has been gradually reducing the size of the program, to $15-billion this month.

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The strong turnaround in the U.S. economy this year, especially in the labour market, convinced the Fed to exit the program, its third bond-buying stimulus since the financial crisis and recession hit in 2008.

Over that time, the Fed used this unconventional and largely untested tool to inject more than $3-trillion into the financial system, despite concerns from critics about the effectiveness of the policy and the potential risks to such a massive expansion of the Fed's balance sheet.

"There has been a substantial improvement in the outlook for the labour market since the inception of its current asset purchase program. Moreover, the committee continues to see sufficient underlying strength in the broader economy," the Fed said in its statement.

"Today the Fed started down the road toward policy normalization that by their own reckoning will be a very long one," said Dawn Desjardins, assistant chief economist at Royal Bank of Canada, in a research note. The end of QE3 is widely regarded as a precursor to the first increase in the Fed's policy interest rate, ," the Fed said in its statement.

"Today the Fed started down the road toward policy normalization that by their own reckoning will be a very long one," said Dawn Desjardins, assistant chief economist at Royal Bank of Canada, in a research note. The end of QE3 is widely regarded as a precursor to the first increase in the Fed's policy interest rate, which hasn't been increased in eight years and has sat at a target of 0 to 0.25 per cent since late 2008.

The Fed left unchanged its "forward guidance" statement on the timing of interest rate increases, continuing to say the target range that "it likely will be appropriate to maintain the 0 to 0.25-per-cent target range for the Federal funds rate for a considerable time following the end of its asset purchase program." But for the first time, it explicitly said in the statement that the timing of the first rate increase will depend on the economic data, not on the calendar – something Fed Chair Janet Yellen has been stressing to market participants in her recent comments.

The Fed left unchanged its "forward guidance" statement on the timing of interest rate increases, continuing to say the target range will likely remain unchanged "for a considerable time" after the end of QE3. But for the first time, it explicitly said in the statement that the timing of the first rate increase will depend on the economic data, not on the calendar – something Fed Chair Janet Yellen has been stressing to market participants in recent comments.

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"If incoming information indicates faster progress toward the committee's  … objectives than the committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later," the statement said.

The Fed also eased its long-standing concern about underlying slack in the labour market, which it has long argued is more prevalent than the current 5.9-per-cent unemployment rate implies, citing such indicators as a low labour force participation rate.

"On balance, a range of labour market indicators suggests that under-utilization of labour resources is gradually diminishing," it said.

The statement fuelled buying in the U.S. dollar, as the market viewed the statement as opening to door for rate hikes even earlier than the anticipated mid-2015 time frame. Many observers had thought the Fed would be more cautious, especially given the recent financial market turmoil.

"The tone of the statement was a bit more hawkish (less dovish) than the market was anticipating," said Bank of Montreal deputy chief economist Michael Gregory in a report.

With the Fed ending the QE3 program, the next step will be to gradually unwind its purchases by selling assets back into the market and restoring its balance sheet to more normal levels, a process that could take several years. Observers have expressed concern that this unwinding could weigh on financial markets and the economy. But the Fed indicated that it doesn't intend to start reducing its balance sheet yet.

Editor's Note: An earlier version of this story said  the Fed injected more than $3-billion into the financial system. In fact, the amount is $3-trillion. This version has been corrected.

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