By Nick Timiraos

WASHINGTON-Federal Reserve officials agreed last month that a strengthening economic growth outlook bolstered their plans to keep raising short-term interest rates this year.

Fed officials late last month believed the economy was set to grow faster than they when they met in December, according to minutes of their Jan. 30-31 meeting, which were released on Wednesday.

After the December meeting, Congress approved tax cuts that were slightly larger than officials had anticipated. Stocks also rose to new highs in the month before the January meeting, likely giving an additional boost to economic growth, they thought.

Stock markets convulsed in the days following the January meeting. Economic reports hinted at rising wage and price pressures, fueling fears the Fed might raise rates faster than expected, and bond yields climbed to their highest levels in four years.

Also after the January meeting, Congress approved a larger-than-expected government spending plan, which has prompted more economists to project the Fed will need to raise rates slightly faster to ensure the economy stays on an even keel.

Officials had already marked up their growth projections when they met in mid-December because Congress was close to agreement on a $1.5 trillion tax cut package.

When officials met in January, several had further marked up their growth forecasts citing rising stock prices and relatively low bond yields as well as "information suggesting that the effects of recently enacted tax changes--while still uncertain--might be somewhat larger in the near term than previously thought," the minutes said.

Others said the prospects for economy to perform better than they expected had also increased. "A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate," the minutes said.

After holding its benchmark federal-funds rate near zero for seven years, the Fed has raised it five times since late 2015 to a range between 1.25% and 1.5%. They also penciled in three quarter-percentage-point rate increases in 2018 and two more moves in 2019.

The Fed is likely to raise rates at its next meeting, March 20-21, which will be the first led by its new chairman, Jerome Powell.

Investors have focused more attention on whether the Fed will feel pressure to add an extra rate increase this year and even more next year. The answer largely turns on inflation.

If Fed officials grow more confident that inflation is rising toward their 2% target over time, they could stick to their tentative plan for three rate increases this year. But if it looks like new federal spending, tax cuts, a weaker dollar and lower unemployment will lead to acceleration in price pressures, policy makers could act more aggressively.

Last year, falling unemployment supported the case for rate increases. The jobless rate declined, to a 17-year low of 4.1% in January.

But inflation pressures weakened, puzzling Fed officials and arguing in favor of slowing the pace of rate rises. Officials said the slowdown would prove transitory, and inflation pressures have firmed up somewhat in recent months.

In December, the Fed's preferred inflation gauge, excluding volatile food and energy categories, rose 1.5% from a year earlier.

At January's meeting, staff economists projected prices in this reading of so-called core inflation would rise "notably faster in 2018."

Prices were already expected to pick up over the coming months because weak readings last March and April will no longer be included in year-over-year comparisons. But the staff forecast also projects further declines in slack across the economy.

Staff economists also delivered a separate briefing on inflation forecasting that largely supported the view recent softness in price pressures would prove transitory.

The tax cuts and federal spending boost recently enacted in Washington could further change this dynamic.

President Donald Trump signed into law a $1.5 trillion tax cut in December, and Congress earlier this month approved a $300 billion increase in government spending over the next two years. Economists expect the measures could boost growth and push down unemployment to levels not seen in more than half a century.

The measures are also likely to raise federal budget deficits and borrowing demands for the U.S. government in a period where the Fed is purchasing fewer Treasury bonds as it attempts to slim down its $4.5 trillion portfolio of bonds and other assets.

In addition to the inflation debate, policy makers faced a separate puzzle in January. Stocks rose to records, long-term bond yields fell, and the dollar weakened, even though the Fed last year steadily raised interest rates and started paring its bond portfolio. Generally in the past, Fed rate increases cased financial conditions to tighten, preventing the economy from overheating.

Fed officials "cautioned that imbalances in financial markets may begin to emerge as the economy continued to operate above potential," the minutes said.

Shortly after Fed officials met, stocks suffered a 10% decline. They have recovered somewhat, and bond yields resumed a climb, with the 10-year Treasury yield sitting at 2.9% before the release of Wednesday's minutes.

So long as market upheaval doesn't spiral out of control, these developments could comfort some officials who had fretted that easy financial conditions might fuel dangerous asset bubbles.

Officials will be closely monitoring both financial markets and economic data to get a better handle on how the new stimulus and the recent volatility ripple through the economy.

Officials have said they expect tax changes to boost consumer spending and capital spending. An upturn in business investment could increase the economy's capacity to produce more goods and services without spurring excessive inflation, a development Fed officials would welcome.

But officials haven't shown conviction in that outcome, noting companies might instead use higher after-tax profits to reduce debt, buy back stock or acquire other firms.

"Several participants expressed considerable uncertainty about the degree to which changes to corporate taxes would support business investment," the minutes said. "Firms may be only just beginning to determine how they might allocate their tax savings among investment, worker compensation, mergers and acquisitions, returns to shareholders, or other uses."

(END) Dow Jones Newswires

February 21, 2018 14:15 ET (19:15 GMT)

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