Federal Reserve Chairman Ben Bernanke speaks during a news conference after central bank policymakers voted in favor of tapering.
Credit: Alex Wong

Tapering is on. 

The Federal Open Market Committee announced Wednesday that it would start winding down its $85-billion-a-month bond-buying program.

Policymakers will start by reducing purchases by $10 billion a month, beginning in January. 

The long-awaited decision sent US stocks sharply higher, because the reduction was so modest. The Dow Jones Industrial Average rose 1.05 percent while the S&P 500 was up 0.74 percent after the announcement at 2:00 p.m. EST. Equities had fallen ahead of the decision. 

Ten-year Treasury yields were up five basis points to 2.89 percent as investors sold fixed-income assets. A reduction in Fed purchases has dampened demand for bonds. 

"In light of the cumulative progress toward maximum employment and the improvement in the outlook for labour market conditions, the committee decided to modestly reduce the pace of its asset purchases,” the Fed said in a statement issued after the two-day meeting.

Fed Chairman Ben Bernanke, who is due to retire in January, told reporters that the central bank expected to continue "modest" reductions of around $10 billion throughout most of 2014, but he noted that the pace of tapering was "data dependent." 

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Investors had been divided over whether the Fed would move this month or wait until January for more evidence that the economic recovery was gaining traction. 

A series of positive readings on the economy had moved the scale in favor of a pre-Christmas taper. 

Financial markets have become addicted to the Fed’s monthly liquidity injections and many investors have been worried that the world’s largest economy was not yet strong enough to absorb a reduction in stimulus spending.

Wednesday's announcement marks the first step towards unwinding the unprecedented stimulus implemented by Bernanke after the 2008 financial crisis triggerred the worst recession in decades. 

But Bernanke repeatedly said  the tapering decision did not signal the Fed was moving away from its "highly accommodative" monetary policy stance.

Interest rates will stay low "well beyond the point that unemployment hits 6.5 percent," he said. The jobless rate is currently 7 percent.

In recent months a series of economic data, from jobs growth and consumer spending to factory output and auto sales, have suggested the world's largest economy is on much stronger footing.

But the annual rate of inflation, currently at 1.2 percent, remains well below the Fed's target of 2 percent and could pose a threat to the recovery.

"Low inflation didn’t stop the Fed from tapering today, but it could be a factor in its next decision, which will come in late-January," Paul Edelstein, Director of Financial Economics at IHS Global Insight, said in an email.

"The tapering guessing game is not over." 

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