WASHINGTON, July 7 (Xinhua) -- The U.S. Federal Reserve currently expects to begin shrinking its balance sheet this year if the economy evolves broadly as anticipated, the central bank said Friday in its semiannual monetary policy report to the Congress.
The Fed also expects that "the ongoing strength in the economy will warrant gradual increases in the federal funds rate," noting that economic activity increased at a moderate pace over the first half of the year and the job market continued to strengthen, according to the report.
The Fed's balance sheet has ballooned to around 4.5 trillion U.S. dollars following three rounds of quantitative easing programs to withstand the impact of the 2008 global financial crisis.
As the U.S. economy is back on track for steady growth, Fed policymakers are preparing to unwind its crisis-era policies to avoid igniting inflation pressures or pumping up asset bubbles.
The Fed last month raised the benchmark interest rates for the fourth time since December 2015 and unveiled a plan to trim its holdings of U.S. Treasury bonds and other mortgage-backed securities later this year.
The report didn't give clues to the sequence of Fed's subsequent rate hikes and beginning of reducing its massive balance sheet. Fed Chair Janet Yellen will testify to Congress next week and is likely to answer questions about their tentative future plans.
At a press conference last month, Yellen said the normalization of Fed's balance sheet could start "relatively soon" if the U.S. economy evolves in line with their expectations.
Most analysts believed the Fed was likely to start shrinking its balance sheet in September, with a further rate increase in December.
The report highlighted that "valuation pressures have increased further across a range of assets, including Treasury securities, equities, corporate bonds, and commercial real estate" since mid-February.
However, these developments in asset markets "have not been accompanied by increased leverage in the financial sector," the report said, adding vulnerabilities in the U.S. financial system remained "moderate."
The report also noted that long-term nominal U.S. Treasury yields have declined and remained quite low by historical standards since the beginning of the year, largely reflecting "declines in inflation compensation" due to soft inflation data.
The core price index for personal consumption expenditures, an inflation indicator favored by the Fed, slowed to 1.4 percent in May from 1.5 percent in April, consistently below the central bank's target of 2 percent, according to the Commerce Department.