By Lindsay Dunsmuir and Jason Lange
WASHINGTON (Reuters) - The Federal Reserve kept interest rates unchanged on Wednesday in its last policy decision before the U.S. election, but signaled it could hike in December as the economy gathers momentum and inflation picks up.
The U.S. central bank said the economy had gained steam and job gains remained solid. Policymakers also expressed more optimism that inflation was moving toward their 2 percent target.
"The committee judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives," the Fed said in a statement following a two-day meeting.
That suggests the bar is low for a rate increase at the Fed's final policy meeting of the year in mid-December, which has largely been factored in by financial markets.
U.S. stocks extended earlier losses and Treasury yields fell after the release of the Fed statement. The U.S. dollar (DXY) briefly pared losses before falling further against a basket of currencies.
"You are still pointing to a December hike, they just didn't pre-commit to it," said John Canally, investment strategist and economist for LPL Financial in Boston.
In the statement, the Fed's increasing confidence that prices were moving higher was reflected in its view that "inflation has increased somewhat since earlier this year" and the removal of its previous reference to inflation remaining low in the near term.
Policymakers have increasingly converged on the likelihood of a December hike. In September, Fed Chair Janet Yellen said that a move before year's end was likely as long as U.S. employment and inflation continued to strengthen.
Since then, job gains have continued at a solid rate and inflation has ticked higher, putting both close to the Fed's long-run targets. The economy also has gained momentum, growing at a 2.9 percent annual pace in the third quarter after a fairly sluggish first half.
ELECTION UNCERTAINTY
Investors had all but discounted an increase in borrowing costs this week ahead of the Nov. 8 U.S. election.
Polls showing Republican Donald Trump gaining ground on Democratic rival Hillary Clinton in the race for the White House sparked a slide on global equities markets, with the benchmark S&P 500 index headed for its seventh straight day of declines.
A Reuters/Ipsos poll released on Monday showed the former secretary of state leading Trump by 5 percentage points, but some other surveys this week put the New York businessman ahead by 1-2 percentage points.
A Trump victory could trigger financial market volatility given investor worries about his stance on trade, immigration and foreign policy. Trump has also accused the Fed of keeping rates low because of pressure from the Obama administration.
"It just reinforces that unless Trump wins and markets become dislocated, the Fed has a green light to tighten," said Jack McIntyre, portfolio manager at Brandywine Global Investment Management in Philadelphia.
The Fed has held its target rate for overnight lending between banks in a range of 0.25 percent to 0.50 percent since last December, when it raised borrowing costs for the first time in nearly a decade.
Kansas City Fed President Esther George and Cleveland Fed President Loretta Mester dissented in Wednesday's decision in favor of an immediate hike. They were among three policymakers who dissented at the last meeting in September.