Federal Reserve Chairwoman Janet Yellen sought to lay the groundwork for interest-rate increases later this year and sounded positive notes on the economy's performance in the past six months.
"The employment situation in the United States has been improving on many dimensions," the central bank's leader told the Senate Banking Committee on Tuesday, her first of two days before lawmakers.
If the economy keeps improving as the Fed anticipates, she added, the central bank "will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis."
With that warning, the Fed leader subtly shifted the Fed's public discussion of the outlook for rates, away from assurances that rates would stay low and toward a discussion of when and how fast they would move up.
Many Fed officials have said recently they would like to have the option to raise rates at midyear, though they're not yet sure they will actually move by then.
The Fed has been saying since December that it would be patient before moving rates higher. Before rates go up, Ms. Yellen noted in her testimony, the central bank would drop this assurance.
An important section of her testimony sought to manage the market's expectations as the Fed looks toward altering its rate guidance. The Fed's next policy meeting is March 17-18 and officials are worried that when they remove the "patient" reference from their policy statement, investors will believe rate increases are imminent.
"It is important to emphasize that a modification of the forward guidance should not be read as indicating that the [Fed] will necessarily increase the target rate in a couple of meetings," Ms. Yellen said.
However, she added that a change in the guidance would put rate increases on the table for discussion at coming policy meetings.
"The modification should be understood as reflecting the [Fed's] judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting," she said.
Ms. Yellen laid out inflation developments in the U.S. as a key to the decision on when rates would rise. Inflation has been running below the central bank's 2% objective for nearly three years and is likely to continue on that path given the recent drop in oil prices. While a stronger job market suggests rate ought to be rising, low inflation gives officials pause.
"Provided that labor market conditions continue to improve and further improvement is expected, the [Fed] anticipates it will be appropriate to raise the target range of the federal funds rate when, on the basis of incoming data, [it] is reasonably confident that inflation will move back over the medium term toward our 2% objective," she said.
Fed officials are likely to be hearterned by the market's response to Ms. Yellen's subtle warnings that interest rates could be on the rise. Stocks rose modestly after her prepared remarks were released and continued rising during her testimony. The Dow Jones Industrial Average was up 72.22 points, or 0.4%, to 18189.06 at midday. Yields on 10-year Treasury notes moved down modestly.
Fed officials have been worried that the mere removal of low-rate assurances could spark market turbulence, pushing stocks down and bond yields much higher, as happened in 2012 when the central bank considered ending a bond-purchase program.
During the question-and-answer session, Ms. Yellen spoke strongly against a proposal by Sen. Rand Paul (R., Ky.) that could subject the Fed's monetary-policy decisions to investigations by the Government Accountability Office. "I want to be completely clear: I strongly oppose "Audit the Fed," " she said in reference to the bill. She said it would politicize Fed decision-making and argued the Fed wouldn't have had the courage to raise interest rates in the early 1980s to beat back inflation if it had been subject to such reviews.
In his opening comment, Senate Banking Committee Chairman Richard Shelby (R., Ala.) said "there is an even greater need for additional oversight" after the financial crisis and the Fed's expansive efforts to boost the economy, though he didn't clearly put his support behind Mr. Paul's proposal.
The Fed is navigating a complex economic backdrop. A variety of job-market indicators that Ms. Yellen watches closely are improving. The jobless rate, at 5.7%, is approaching low levels where many Fed officials believe it could settle in for the long run. Payroll growth averaged 280,000 a month in the second half of 2014. Long-term unemployment has dropped and fewer workers are reporting they can only find part-time work.
At the same time, the Fed leader highlighted a host of risks overseas.
"In China, economic growth could slow more than anticipated, as policy makers address financial vulnerabilities and manage the desired transition to less reliance on exports and investment as sources of growth," she said. "In the euro area, recovery remains slow, and inflation has fallen to low levels."
Even on these points, however, the Fed chairwoman sounded optimistic notes.
"We could see economic activity respond to the policy stimulus now being provided by foreign central banks more strongly than we currently anticipate," she said, adding, "the recent decline in world oil prices could boost overall global economic growth more than we expect."
The Fed's official report to Congress on monetary policy, presented along with the testimony, highlighted declining gasoline prices would provide a "significant boost" to U.S. consumers.
Ms. Yellen was nudged both ways by lawmakers on interest rates.
"I urge caution," Sen. Charles Shumer (D, N.Y.) told Ms. Yellen, saying the Fed should wait until wages are clearly rising before it raises rates.
"The financial crisis over," countered Sen. Past Toomey (R., Pa). "The time for normalization is well overdue."
Ms. Yellen took a middle line.
"This is a balancing of costs and risks that we're trying to make in a deliberate and thoughtful way," she said.
Write to Jon Hilsenrath at, Pedro Nicolaci da Costa at and Ben Leubsdorf at

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(END) Dow Jones Newswires
February 24, 2015 10:10 ET (15:10 GMT)
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