By Howard Schneider and Michael Flaherty
WASHINGTON (Reuters) - The Federal Reserve is preparing to consider interest rate hikes "on a meeting by meeting basis," Fed Chair Janet Yellen told a congressional committee on Tuesday in a subtle change of emphasis in how the Fed has been speaking about its plans for the first interest rate increase since 2006.
In prepared remarks to the Senate Banking Committee Yellen described how the Fed's rate-setting policy committee will likely proceed in coming months - an effort to increase the Fed's flexibility and mute any potential market reaction as the central bank approaches its "liftoff" date.
The committee will first drop the word "patient" from its statement, part of a phrase used since December to describe the Fed's approach to the timing of an initial rate hike, Yellen said.
But that is no guarantee rates will be raised at any given point, Yellen said. Rather it will be a signal that the Fed was shifting into a meeting by meeting consideration of a rate increase.
"If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis," Yellen said. "Before then, the Committee will change its forward guidance. However it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings."
Yellen's discussion of forward guidance was part of prepared testimony that included a broad overview of a U.S. economy that appeared to be surging forward with strong job growth and a continued post-crisis expansion - conditions largely consistent with a rise in interest rates sometime later this year.
However, Alabama Republican Senator Richard Shelby, the chair of the Senate Banking Committee, indicated he was interested in what he considered more fundamental issues such as whether Congress should take a more aggressive role in overseeing the Fed. He has scheduled a separate hearing on that issue next week, and challenged Yellen on the issue in his opening statement.
With a more than $4 trillion balance sheet from its various crisis fighting efforts, "many question whether the Fed can rein in inflation and avoid destabilizing asset prices," Shelby said. "I am interested to hear whether the current Chair...believes the Fed should be immune from any reforms."
Yellen's prepared remarks will be followed by a question and answer session, and a repeat appearance before a House committee on Wednesday.
Just completing her first year as Fed chair, Yellen said she felt U.S. labor markets and other key economic indicators "have been increasing at a solid rate." However, she said she still feels the job market is not fully repaired, and that the U.S. outlook remains somewhat clouded by a weaker-than-hoped-for global economy, stalled wage growth, and falling inflation.
None of those factors on their own may be enough to keep the Fed from raising interest rates later this year, perhaps as early as June. Rates have been near zero since the financial crisis hit in 2008, part of a record effort by the central bank to repair the damage of the Great Recession.
But the lack of inflation has made some Fed policymakers hesitant to commit to raising rates until they are more certain the U.S. is not headed down the same path as Europe or Japan, mature industrial economies that are struggling to maintain growth. The Fed considers a steady 2 percent annual inflation rate a sign of overall economic health - consistent with its own ability to return interest rates to a normal level, and not so high or low that it distorts household and business spending and investment decisions. Though the current weak prices are considered likely to be a temporary result of oil's collapse, doubts remain.
Yellen's statement could set the stage for the Fed to remove "patient" as soon as its next meeting in March: several policymakers, including some centrists on the committee, have said they feel an interest rate increase should be on the table by June, after the intervening Fed session in April.
The discussion of forward guidance in Yellen's testimony is an effort to extricate the Fed from a perhaps unforeseen constraint it created when the word "patient" was put in its statement in December. Yellen defined patient as a "couple" of meetings, and policymakers soon became concerned, according to the most recent Fed minutes, that investors would view any removal of "patient" as a sign interest rates would definitely rise two meetings later.
(Reporting By Howard Schneider and Michael Flaherty; Editing by Andrea Ricci)
