Wide economic slack to keep Fed on buying track
WASHINGTON (Reuters) - Improving prospects for the U.S. economy are not likely to divert the Federal Reserve from its plans to buy $600 billion worth of bonds as long as modest growth does little to dent high unemployment.
Analysts caught off guard by the Fed's downbeat view of the economy on Tuesday were forgetting the central bank's intense focus on how far the U.S. economy needs to go before reversing the setbacks of the recession and the financial crisis.
"We think it's going to be a very high bar for them not to do the full $600 billion," said Dean Maki of Barclays Capital. "To cut the program short, they would need much stronger data."
The Fed emphasized in a statement after its Tuesday meeting that while the economy is continuing to make progress, it is not growing at a rate sufficient to bring down unemployment.
A spate of recent surprisingly strong economic data and the prospect of new fiscal stimulus from a tax-cutting bill working its way through Congress have led some analysts to speculate that the central bank could curtail its bond buying plan.
However, the Fed is well short of where it wants to be in achieving its key objectives -- full employment and price stability.
The unemployment rate rose to 9.8 percent last month from 9.6 percent in October as employers added a meager 39,000 jobs. Officials view a rate between 5 percent and 6 percent as representing full employment.
At the same time underlying inflation as measured by the Fed's preferred gauge hit a record low of 0.9 percent in October. The Fed's implicit target would put that close to 2 percent.
After a loss of 8 million jobs during 2008-2009, the recovery in the eyes of top Fed officials has a long way to go. After a meeting in June, Fed officials said the downturn had been so severe, it could take the economy five to six years to fully return to normal levels of growth, employment and inflation.
"The unemployment rate is just not going down," Bernanke told the CBS News program "60 Minutes" eight days before this month's Fed meeting. "Unemployment is just about the same as it was in mid-2009, when the economy started growing. So, that's a major concern."
NO INFLATION WORRIES YET
Some analysts argue the Fed is endangering the recovery by ignoring the improving outlook, and they point to a sharp increase in bond yields as a danger sign of worries that the Fed is throwing fuel on a fire that could get out of hand.
A Reuters poll conducted after the Fed's meeting on Tuesday found that only five of 16 primary dealers think the central bank might expand the bond buying program beyond its expiration in mid-2011, down from 12 of 16 a month ago.
"Once investors fear the Fed is too focused on carrying out QE2 and not enough on the risks of future inflation, it sets the stage for a sell-off in bonds that could escalate globally," said Bernard Baumohl of Economic Outlook Group in Princeton, New Jersey.
Fed policymakers have consistently argued that rock bottom overnight borrowing costs, a first round of $1.7 trillion in long-term asset purchases, and now the second bout of bond buying will not ignite an inflation inferno because there is so much slack in the economy and therefore ample room for growth.
The central bank has also spent considerable political capital in committing to renewed easing, encountering harsh international and domestic political criticism. Several members of the Fed's policy-setting panel have openly expressed skepticism about the program as well.
While the Fed's somber tone on Tuesday surprised many economists who expected a bigger nod to signs the recovery was perking up, the central bank likely wanted to be careful not to say anything to suggest its resolve was wavering in pushing forward on its second round of so-called quantitative easing.
"The Fed was never going to perform a u-turn and shrink the size of QE2 just six weeks after announcing it," said Paul Dales, an economist for Capital Economics in Toronto.
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