Glum Fed keeping easing options open, minutes show

WASHINGTON Wed Jul 11, 2012 8:33pm EDT

The Federal Reserve Building is reflected on a car in Washington September 16, 2008. REUTERS/Jim Young

The Federal Reserve Building is reflected on a car in Washington September 16, 2008.

Credit: Reuters/Jim Young

WASHINGTON (Reuters) - The U.S. Federal Reserve is open to buying more Treasury bonds to stimulate the economy, but the recovery might need to weaken for a consensus to build, minutes from the central bank's June meeting released on Wednesday showed.

The Fed last month expanded its latest effort to keep long-term interest rates low, announcing it would buy an additional $267 billion in long-term bonds with proceeds from short-term debt in a measure known as Operation Twist.

Even given that modest step, many economists expect the U.S. central bank to ease monetary policy further by eventually launching a third round of outright bond purchases that would increase the size of its $2.9 trillion balance sheet.

The minutes of the June 19-20 meeting showed a few officials on the policy-setting Federal Open Market Committee thought recent softness in the economy was sufficient to justify bolder action. But the report suggested a majority of policymakers was not yet on board - at least not before last week's employment report, which showed a paltry 80,000 jobs were created in June.

"Several (members) noted that additional policy action could be warranted if the economic recovery were to lose momentum, if the downside risks to the forecast became sufficiently pronounced or if inflation seemed likely to run persistently below the committee's longer-run objective" of 2 percent, the minutes said.

U.S. stocks mostly extended losses on the report, which failed to give investors the sort of assurance about further quantitative easing, or QE, that some had been hoping for.

"We really don't see any clear indication in these minutes that the Fed is any closer to QE3 than at their previous meeting," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. "Very cautious on the economic outlook and the door remains open to QE3, but nothing imminent in these minutes."

Fed Chairman Ben Bernanke testifies on monetary policy before Congress next week and financial markets will search his remarks for clues on whether the latest jobs data has moved the central bank any closer to a further easing of monetary policy.

The Fed, which has held overnight interest rates near zero since December 2008, has already bought $2.3 trillion in government and mortgage-related debt.

Given concerns about the size of the balance sheet, Fed officials were looking into what else they might do to support the economy. Still, analysts were puzzled by a cryptic reference that offered little in the way of concrete detail.

"Several participants commented that it would be desirable to explore the possibility of developing new tools to promote more accommodative financial conditions and thereby support a stronger economic recovery," the minutes said.

GLOBAL SLOWDOWN

The U.S. economy grew just 1.9 percent in the first quarter, and many economists believe it turned in an even weaker performance over the past three months.

Employment growth dropped to an average of just 75,000 per month in the second quarter from 226,000 in the first three months of the year. By a loose rule of thumb, the economy would need to add about 125,000 jobs per month to bring down the unemployment rate, which stuck at 8.2 percent in June.

Forecasts released after the Fed's meeting last month showed policymakers had sharply downgraded their projections for economic growth. They now see the economy expanding between 1.9 percent and 2.4 percent this year, a sharp change from April's forecast range of 2.4 percent to 2.9 percent.

Part of the shift came from the outlook overseas as Europe remains mired in an intractable political crisis over its banks and sovereign debt markets, while key emerging economies like China are showing signs of fraying.

A Reuters poll of 16 U.S. primary dealers -- the large financial institutions that do business directly with the Fed -- taken after the June jobs numbers showed that they see a 70 percent chance the central bank will ease policy again.

The minutes showed 11 Fed meeting participants based their forecasts on the assumption Operation Twist would be extended, while two presumed more bond purchases.

While they extended Twist, many officials were skeptical the decision would have much effect, the minutes said. Some also expressed unease at buying more long-term Treasury debt.

"Some members noted the risk that continued purchases of longer-term Treasury securities could, at some point, lead to deterioration in the functioning of the Treasury securities market that could undermine the intended effects of the policy," the minutes said.

"However, members generally agreed that such risks seemed low at present, and were outweighed by the expected benefits of the action," the report added.

The minutes said the Fed's staff, like the policymakers themselves, revised their GDP forecast downward in June and showed they believed the economy would make little headway in reducing unemployment until 2014.

The minutes also showed that the central bank is considering publishing a single consensus economic forecast as part of its ongoing bid to communicate more clearly with financial markets, although policymakers were uncertain how that might be done.

Bernanke instructed a communications subcommittee to study the matter.

(Additional reporting by Nick Olivari; Editing by Neil Stempleman, James Dalgleish, Gary Crosse)

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