Fed Officials Expected to Keep Rates Steady

Federal Reserve officials are likely to keep interest rates steady at their policy meeting this week and drill down into details about when and how to reduce their large holdings of mortgage and Treasury securities.

The challenge in their postmeeting policy statement will be to acknowledge the handful of disappointing economic growth indicators since officials last gathered in mid-March without suggesting they are ready to veer from the policy path they have sketched out at recent meetings. The two-day policy meeting begins Tuesday.

Officials raised interest rates at the March meeting to a range between 0.75% and 1% and penciled in two more quarter-percentage point increases this year. They also believe they are on course to signal late in the year that they will begin winding down their securities portfolio.

Gross domestic product grew at a 0.7% annual rate in the first quarter, as consumers reined in spending despite a surge in household confidence surveys and a rise in stock prices. The report isn't likely to cause too much alarm at the Fed because of signs temporary factors suppressed spending and because the economy in recent years has slowed at the start of the year before picking up speed in the spring and summer.

Inflation also weakened unexpectedly in March. The Labor Department's consumer-price index declined a seasonally adjusted 0.3% in March from the prior month, and prices excluding food and energy fell 0.1%, the first decline for so-called core prices since 2010.

Still, officials believe the economy is near full employment, meaning inflation should slowly build in the months ahead. The unemployment rate fell to 4.5% from 4.7%, hitting its lowest level in almost a decade.

Fed officials have signaled in public statements and interviews any disappointing data points haven't been enough to change their rate outlook.

Given recent seasonal patterns, "something that looks like 1% in the first quarter -- it might be actually more like 2% in reality," said New York Fed President William Dudley after a speech in New York on April 7.

After years of pushing down on the gas pedal, the Fed's job now is to allow "the economy to kind of coast and remain on an even keel, to give it some gas, but not so much that we're pressing down hard on the accelerator," said Fed Chairwoman Janet Yellen in remarks on April 10 in Ann Arbor, Mich.

Continuing to gradually remove large amounts of stimulus "seems likely both to maximize the prospects of a continued expansion in the U.S. economy and to mitigate the risk of undesirable spillovers abroad," said Fed Vice Chairman Stanley Fischer in remarks at a conference in Washington on April 19.

Also, potential growth shocks from abroad, which forced the Fed to scale back its plans to raise rates in 2015 and 2016, have held at bay so far this year. More resilient global growth is making officials less worried about the latest batch of somewhat discouraging domestic data.

"The global economy, which was quite weak, now seems to be operating in a slightly more robust and healthier way," Ms. Yellen said in Ann Arbor.

With that as a backdrop, officials are comfortable with market expectations about their next move. Traders in futures markets placed a 63% probability on a Fed rate increase by then, according to CME Group.

That is up from less than 50% before the first round of voting in the French election on April 23. Markets rallied after centrist candidate Emmanuel Macron advanced to the final round of voting on May 7 against Marine Le Pen, the far-right nationalist who would withdraw France from the European Union's common currency.

Financial conditions have been mixed since the Fed last met in March. Stock markets have pulled back from their highs earlier this year, while bonds have rallied, sending down yields. The 10-year Treasury yield fell from 2.63% on March 13, its highest level of the year, to 2.28% on Friday. A Goldman Sachs index shows that taken altogether financial conditions eased in April to levels last seen in August.

With the economy on better footing, officials are moving quickly to fill in details about how they will address their $4.5 trillion securities portfolio. That discussion began in earnest at the March meeting but officials still need to work through myriad technical details for how to reduce the portfolio, which was ramped up during and after the financial crisis to provide added stimulus to the economy.

Officials want their benchmark federal-funds rate to remain the primary tool for managing monetary policy, meaning they would like the balance-sheet wind-down to run quietly in the background once they start the process. The official account of the March meeting indicated officials were leaning toward gradually tapering the reinvestments of principal payments on Treasury and mortgage securities as opposed to stopping them cold turkey, but said no decision had been reached.

Write to Nick Timiraos at nick.timiraos@wsj.com