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Yellen says economy still needs high degree of Fed support and cautions about 'false dawns'

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WASHINGTON - Despite recent sizable job gains, Federal Reserve Chair Janet Yellen is signalling that her agency is in no rush to withdraw the massive support it is providing the U.S. economy.

Extra caution is warranted, she said Tuesday, given a number of "false dawns" in this recovery when a hoped-for acceleration in growth has failed to materialize.

"Although the economy continues to improve, the recovery is not yet complete," she told the Senate Banking Committee, delivering the Fed's semi-annual economic report to Congress.

Analysts said that Yellen's remarks indicated that the central bank plans to keep its benchmark short-term interest rate near a record low of zero, where it has been since December 2008, for some time to come.

While many economists believe the Fed will delay its first rate hike until next summer, some had wondered whether a recent string of better-than-expected unemployment numbers might cause that date to be moved up.

Yellen acknowledged the improvement in the labour market, where the unemployment rate fell to 6.1 per cent in June. But she said this rate was still above the 5.2 per cent to 5.5 per cent that Fed officials view as optimal. She said there were still far too many long-term unemployed Americans and wage growth remained weak, all indications of "significant slack" remaining in the job market.

On inflation, Yellen noted that prices by the Fed's favoured price gauge were up 1.8 per cent in the 12 months ending in May, and she noted that this was still below the Fed's 2 per cent target.

"Yellen's message was that we have made progress on the economy, but we still have a ways to go," said Stuart Hoffman, chief economist at PNC Financial. He predicted the first rate hike will not occur until October 2015.

Yellen's comments on Tuesday, which hewed closely to the remarks she made at a news conference following the Fed's June meeting, had little impact on financial markets although stocks of some Internet and biotech companies were jolted by a reference in the agency's Monetary Policy Report that stock valuations of "social media and biotechnology firms appear to be stretched."

While the reference brought back memories of former Fed Chairman Alan Greenspan's famous comment in a December 2006 speech about possible "irrational exuberance" in the stock market, analysts noted that Yellen in her testimony played down worries about asset bubbles.

She told Congress that while prices of real estate, stocks and corporate bonds had risen, those prices remained generally in line with historic norms. She also repeated her view that government regulators had better ways to control asset bubbles than using such a blunt-force instrument as hiking interest rates.

Yellen repeated the language in the Fed's last several policy statements that the central bank expected to keep short-term rates near zero for a "considerable period" after it ends its monthly bond purchases, which have been designed to keep long-term rates low.

Pressed to be more specific, Yellen cited the individual forecasts released at the last meeting that showed 12 members of the Fed's 19-member policy panel expect the first rate hike to occur in 2015 with later increases likely to be gradual. Many were expecting a federal funds rate of 1 per cent or less at the end of next year.

In answering questions Tuesday, Yellen said that while the recent drop in the unemployment rate was encouraging, she noted past periods in this sub-par recovery where hopes about stronger growth fizzled. She said that with its key short-term rate already near zero, the Fed has no margin for error.

"The Federal Reserve does need to be quite cautious with respect to monetary policy. We have in the past seen sort of false dawns, periods in which we thought our growth would speed, pick up and the labour market would improve more quickly and later events have proven those hopes to be unfortunately over-optimistic," she told the committee. "We need to be careful to make sure that the economy is on a solid trajectory before we consider raising rates."

Yellen confirmed a date revealed last week in the minutes of the June meeting that the Fed's bond purchases, which have been aimed at keeping long-term rates low, will likely be halted altogether at the October meeting. They are currently at $35 billion per month, down from $85 billion last year.

The Fed chair said that there was an active debate on the Fed's approach to unwinding the bond program with more details expected to be released before the end of the year. Financial markets are closely watching that process given that the Fed's decision on how it sells off its assets could have a significant impact on interest rates.

Yellen stressed that the Fed's future actions will depend on how well the economy performs. She said that if labour market conditions continue to improve more quickly than anticipated, the Fed could raise its key short-term interest rate sooner than currently projected. But she said weaker conditions would mean a longer period of low rates.

She is scheduled to testify on Wednesday before the House Financial Services Committee.

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