Fed links rates to state of US economy The US Federal Reserve will keep interest rates exceptionally low until unemployment falls below 6.5 per cent in a historic monetary policy innovation. The central bank will keep rates low as long as it does not forecast inflation a year or two ahead to be greater than 2.5 per cent. The change means that, for the first time ever, the world's largest central bank has tied its interest rate policy directly to the state of the economy. The Fed's goal is to offer reassurance that rates will remain low for as long as the economy remains weak. If the economy got weaker, then markets would automatically expect rates to stay lower for longer, because the unemployment condition would not be triggered. But the move also carries risks for the Fed. If it has misjudged the health of the economy, then inflation might start to rise before unemployment falls to 6.5 per cent, forcing it to violate its pledge or else let price rises get out of control. The new language replaces the Fed's earlier pledge of low rates "at least through mid-2015." According to its statement: "The committee views these thresholds as consistent with its earlier date-based guidance." The Fed also beefed up its programme of asset purchases to $85bn a month in what is effectively a fourth round of quantitative easing. In an effort to strengthen the economic recovery, the central bank will increase its outright asset purchases by buying $45bn a month of Treasury securities, in addition to $40bn a month of mortgage-backed securities, until there is a substantial improvement in the labour market. The dollar came under renewed pressure and government bond prices eased after the new Treasury purchases plan was announced. US equities rose to new session highs with the S&P 500 up 0.7 per cent. The yield on 10-year notes rose to 1.69 per cent, up 4 basis points. The dollar was 0.3 per cent lower on a trade weighted basis. Spot gold in New York jumped $11 an ounce to $1,721. The expansion of outright asset purchases replaces an expiring programme called Operation Twist. Under Twist, the Fed sold bonds close to maturity, and bought those with longer to run; now it will just create bank reserves to finance purchases. The goal of both types of purchase is to reduce the supply of long-term assets such as Treasury bonds, driving down interest rates on mortgages and other loans, and thus speeding up economic growth. The launch of the new economic conditions as well as additional asset purchases marks an all-out effort to drive the stuttering recovery forward. The Fed now has an open-ended commitment to keeping interest rates low, as well as open-ended asset purchases at close to the fastest speed that market liquidity will allow. It signals that the central bank remains seriously concerned about risks to the economy, such as the imminent fiscal cliff of tax rises and spending cuts, and has taken little heart from better recent data on the housing market.