Fed's Pianalto says more easing could be warranted

ERIE, Penn. Tue Jul 17, 2012 3:24pm EDT

ERIE, Penn. (Reuters) - Policy easing by the U.S. Federal Reserve, including buying more bonds, could be warranted if the U.S. economic recovery continues to sputter, as recent data suggest, a top Fed official said on Tuesday.

"If the expansion were to continue to lose momentum, and inflation threatened to run persistently below 2 percent, additional policy action could be warranted," Cleveland Fed President Sandra Pianalto said in remarks that struck a slightly more dovish tone than in May, when she last publicly addressed monetary policy and the economy.

However Pianalto, who has a vote this year on the U.S. central bank's policy-setting panel, warned that the benefits of the Fed's so-called quantitative easing programs have their limits.

"We are using large-scale asset purchases as a policy tool in an unusual financial and economic environment - one in which future benefits may be more muted," she told an Economic Research Institute of Erie conference. "Nonetheless, if warranted, further asset purchases would have benefits."

Pianalto, in the dovish core of Fed policymakers alongside Chairman Ben Bernanke, also lowered her U.S. growth expectations, suggesting four straight months of disappointing jobs creation as well as persistent economic headwinds from Europe and China prompted the policymaker to shift her stance somewhat.

Earlier on Tuesday, Bernanke told the U.S. Senate Banking Committee that the Fed was moving closer to unleashing a fresh round of monetary stimulus, repeating the central bank's pledge to act if needed.

Despite a modest uptick in the housing market, recent U.S. economic data from manufacturing to retail sales show the world's largest economy has tripped in the last few months, leading some to predict the Fed will buy more bonds in a third round of quantitative easing (QE3).

LIMITS TO QE3

Though Pianalto said the economy is "still struggling to gain traction, and remains in the grip of headwinds holding back stronger progress," she cautioned that the effects of QE3 need more analysis.

"U.S. monetary policy cannot solve Europe's fiscal and banking problems, nor can it put U.S. fiscal policy on a sustainable trajectory," she said.

The Fed in late 2008 slashed interest rates to near zero and has since bought $2.3 trillion in long-term securities in an unprecedented drive to spur growth and revive the economy after the worst recession in decades.

Yet with the slow recovery and unemployment high at 8.2 percent, the central bank has said it expects to keep rates "exceptionally low" at least through late 2014. The Fed repeated that conditional pledge in June, and prolonged to the end of the year a bond maturity-extension program called Operation Twist, a move Pianalto backed.

Based on today's "highly accommodative" monetary policy, Pianalto said she now expects 2012 gross domestic product growth of around 2 percent, down from a previous forecast of "slightly above 2.5 percent."

The pace of growth should pick up gradually through 2014, but the unemployment rate should remain above 7 percent by the end of that year, she said.

U.S. GDP growth in the first quarter was 1.9 percent, and economists think it dropped even lower in the second quarter, raising fears that the expansion might peter out.

(Reporting by Kim Palmer, Writing by Jonathan Spicer; Editing by Chizu Nomiyama and James Dalgleish)

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