Fed to test new tool for withdrawing stimulus

The U.S. Federal Reserve Building is pictured in Washington, December 15, 2009.

WASHINGTON (Reuters) - The Federal Reserve on Friday announced plans to test a new facility it could use to withdraw some of the extraordinary stimulus it pumped into the economy during the recession, but stressed it was not embarking on a tightening of monetary policy yet.

The Fed announced three auctions of short-term deposits and said two more could follow. The auctions will offer around 8,000 banks around the country a chance to park reserves at the Fed and earn interest, effectively taking those funds out of general circulation in the economy.

"These auctions are a matter of prudent planning and have no implications for the near-term conduct of monetary policy," the U.S. central bank said in a statement.

Fed officials have made clear for months they would use a process similar to the certificates of deposit banks offer customers. The tool gives the Fed the chance to drain reserves from the financial system when they want to begin to tighten financial conditions as the economy recovers from recession.

"Nothing that we see here looks unusual relative to what we would have expected," said Michael Feroli, an economist at JPMorgan Chase Bank in New York. "It's a very long, predetermined process."

The Fed bought about $1.4 trillion in mortgage-related debt and $300 billion worth of longer-term Treasury securities in a bid to provide additional punch to the flagging economy after it had already cut borrowing costs to near zero. At about $2.3 trillion, the Fed's balance sheet has ballooned from its pre-crisis level of about $900 billion.

Policy makers have signaled they will keep rates exceptionally low for an extended period. But they have mapped out methods for draining reserves from the system, including offering term deposits and reverse repurchase agreements.

The term deposit auctions announced on Friday are in effect dry runs of a facility that could become much larger if it is successful. The Fed has already conducted trial reverse repurchase agreements, in which it sells securities to financial firms that deal directly with Fed with an agreement to sell them back later for a slightly higher price.

Policy makers hope that pulling back funds from banks on a larger scale will limit the risk of inflation from having so much credit sloshing around the financial system. The Fed also believes that by absorbing reserves, it will have more control over the benchmark interest rates it targets to rein in any overheating in the economy when needed.

The first auction will be for $1 billion of 14-day deposits on June 14. Auctions of 28-day and 84-day deposits will follow for amounts yet to be announced.

The maximum rate at auction will be for no more than the discount rate, the cost of emergency loans from the Fed.

The Fed said it could hold up to two additional term-deposit auctions later in the summer.

(Reporting by Mark Felsenthal; Editing by Chizu Nomiyama and Leslie Adler)