Benefits of QE3 seen outweighing oil sting

NEW YORK Wed Sep 12, 2012 7:11pm EDT

NEW YORK (Reuters) - Not long after the Federal Reserve announced in 2010 that it was going to pump money into the U.S. economy, oil began climbing and didn't stop until prices had risen by $40.

Don't expect that to put the Fed off from a new round of bond-buying, which it could announce on Thursday.

Expectations are high that the central bank will resort to so-called quantitative easing for a third time, or QE3, when policymakers conclude a two-day meeting on Thursday.

The Fed is gravely concerned about the high U.S. unemployment rate and sputtering economic recovery, and it could decide that buying bonds or mortgage-backed securities would help kick start the economy and get Americans back to work.

But the stimulus could bring a short-term sting to consumers from higher oil and fuel prices. Brent crude prices topped $120 a barrel in the months after QE2 was announced in 2010.

Talk of a third round of stimulus has been cited in recent months as supporting oil's steady climb from below $90 in June to $115 a barrel on Wednesday.

Still, economists say today's stable inflation expectations and current U.S. gasoline prices, though high, do not threaten the wider economy, thus allowing the Fed to take action.

"I don't think the Fed likes that oil goes up when they do these things ... but they see broader benefits than just a couple of dollars here and there in your gas tank," said Thomas Simons, money market economist at Jefferies & Co.

"The Fed seems to be very dismissive of commodity prices," he added, noting that in the past, Fed Chairman Ben Bernanke and other policymakers correctly argued that price rises from QE1 and QE2 would be temporary.

Commodities markets have been sensitive to Fed policy, with some analysts arguing the increased money supply has temporarily drawn investors to pour cash into asset classes with more risk, such as equities and oil.

Economists gave a 60 percent chance that the Fed will launch QE3 this week, according to a Reuters poll done on Friday.

Since the height of the financial crisis in late 2008, the U.S. central bank has kept short-term rates effectively at zero and bought $2.3 trillion in assets in an unprecedented drive to revive the economy from the worst recession in decades.

Quantitative easing is meant to spur the recovery by keeping borrowing costs low and encouraging spending, hiring and overall growth. While some Fed policymakers opposed QE1 and QE2 on grounds that such massive cash infusions risked an explosion in prices, inflation has instead remained contained.

Indexes measuring both overall and core prices in the United States have been below the Fed's 2 percent target since March.

At its last meeting, Fed policymakers lowered their inflation expectations for this year.

After its policy meeting in April, when crude was hovering near $120 a barrel, the Fed said the "increase in oil and gasoline prices earlier this year is expected to affect inflation only temporarily, and the Committee anticipates that subsequently inflation will run at or below" 2 percent.

Around the same time, researchers at the Federal Reserve Bank of San Francisco published a paper arguing that oil, natural gas and agricultural crops accounted for only one percentage point of the 10 percent cumulative rise in personal consumption expenditures prices from January 2007 to December 2011, suggesting concern over the inflationary effects of commodity price increases may be overdone.

Bernanke, who has defended the Fed's aggressive response to the Great Recession, referred to commodities only in passing during a major policy speech in Jackson Hole, Wyoming, last month.

Oil analysts said that ultimately the concern for U.S. consumers will be the price of gasoline, which averaged near $3.86 a gallon on Wednesday, according to motorist group AAA, well under the record above $4.11 struck in 2008 when oil prices approached $150 a barrel.

"I think you have to have gasoline well over $4 per gallon to have a significant impact on the economy," said Sarah Emerson, director of Energy Security Analysis Inc.

"At $3.80, gasoline is only 3 to 4 percent of household expenditures. You have to get the number up to the 8 to 9 percent range to get people to shift where they spend their money."

(Reporting by Jonathan Spicer; Editing by Kenneth Barry)

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