FED FOCUS-Fed groundwork for easing avoided market lurch

WASHINGTON Nov 3 (Reuters) - An underwhelming financial market response to the Federal Reserve's massive new round of bond buying on Wednesday is unlikely to dismay central bank officials who carefully telegraphed the move to avoid market disruptions.

The Fed said it will buy $600 billion of Treasuries by the middle of next year to stimulate a weak recovery -- a second round of quantitative easing, or QE2 for short.

Even though the program could put more than a third of any given Treasury security issuance in Fed hands, market reaction was muted.

"Less shock, same awe," was how Michael Feroli, an economist at JPMorgan in New York, put it in the headline of a research note.

Stocks ended a volatile session modestly higher slightly higher and medium-term debt prices rose. The dollar fell against the euro after the Fed but rose against the yen.

Analysts said markets had widely priced in the Fed move prior to the announcement, which was for a slightly higher amount than expected but would spread purchases out over a longer period than anticipated.

The Fed had already cut short-term interest rates to near zero and pumped $1.7 trillion into the economy through purchases of Treasuries and mortgage-related debt. It had been charting an exit from those easy-money policies until the U.S. recovery showed signs of fading over the summer.

However, rather than disappointment that the new buying program was receiving a cool reception, Fed officials will see the market's yawn as a sign they successfully signaled the rough size and scope of the program in advance.

An unusually active round of public appearances by Fed officials -- in which so-called "doves" supporting further easing played an especially prominent role -- was a crucial element in the central bank's plan to prepare markets.

Since Fed Chairman Ben Bernanke first said in August the Fed was considering reviving asset purchases to spur the sluggish recovery, stocks have climbed around 13 percent and yields on inflation-protected government debt have fallen.

Analysts polled by Reuters on Oct. 27 expected a median $500 billion in purchases. The size and scope of the program as announced reflects a view at the Fed that $600 billion in bond buys roughly translates to about a three-quarter percentage point cut in overnight interest rates.

Stretching out the new purchases over more than seven months at a $75 billion per month clip is a way for the Fed -- which will be buying a further $35 billion a month as it reinvests proceeds from maturing assets it already holds -- to avoid overwhelming markets with its presence. The Fed noted that its overall Treasury buying could total $900 billion by the middle of next year.

The Fed also said it could adjust the size and scope of its buying, but it is unlikely to just tinker around the edges.

Instead, it will assess over its next several meetings whether the program is hitting the mark, and any changes would probably be significant.

Policy-makers also continue to debate the merits of using other tools to spur growth, including cutting the interest rate banks earn on the excess reserves they hold at the central bank. The Fed could also announce that it will temporarily encourage a higher rate of inflation than normally desirable.

The Fed's move to further easing has stirred controversy both domestically and internationally.

Republican lawmakers, who seized control of the House of Representatives in elections on Tuesday, have criticized the Fed for printing money to fund government profligacy.

"Diluting the value of the dollar by continually increasing the supply of money poses an incalculable risk," Representative Mike Pence, a House Republican leader, said after the Fed's decision.

But most Fed officials feel those criticisms are off base. They argue the Fed has always bought Treasury securities to conduct monetary policy, and that their actions are aimed at stimulating growth, not helping the government pay its bills.

When the recovery accelerates, the Fed has promised to drain money from the financial system by raising interest rates before a troubling inflation takes hold.

The Fed has also been a target of international criticism since its policy has weakened the dollar and driven investors into emerging markets, spurring fears of boom and bust abroad and making exports from those countries less competitive.

While U.S. central bankers acknowledge those concerns, they say it is unfair to blame only the United States for global imbalances.

Countries that keep their exchange rates artificially low, as many believe China does, create problems for countries whose currencies float more freely, they would say. Further, they believe a strong U.S. economy is essential for healthy global growth.