UPDATE 2-Fed says U.S. economy posted modest growth in Jan-Feb

Wed Mar 6, 2013 4:52pm EST

* Fed's Beige Book continues to report signs of modest growth

* Housing firm in all Fed districts with prices higher, inventory down

* U.S. fiscal policy denting retail sales but demand for cars up

By Alister Bull

WASHINGTON, March 6 (Reuters) - U.S. economic growth continued to improve gradually in January and early February as consumer spending picked up and the country's battered housing market maintained a broad-based recovery, the Federal Reserve said on Wednesday.

In a cautiously optimistic report from its 12 regional branches that delivered largely positive feedback from business contacts, the U.S. central bank also highlighted downside risks caused by ongoing budget battles in Washington.

"Reports from the twelve Federal Reserve districts indicated that economic activity generally expanded at a modest to moderate pace since the previous Beige Book," the Fed said.

The report was close in tone to the previous Beige Book, released on Jan. 16, and did not alter the outlook for continued aggressive Fed action to support a tepid recovery which faces headwinds and uncertainty, notably from U.S. fiscal policy.

"For the Fed, it's slow progress, but not enough to alter its rate of asset purchases," said economist Yelena Shulyatyeva at BNP Paribas in New York.

U.S. growth slumped to a mere 0.1 percent annual pace in the final three months of last year. But the Fed expects the economy to maintain a gradual recovery, helped by near-zero interest rates and its own massive bond buying program to spur borrowing. It is currently buying bonds at a $85 billion monthly pace.

The Beige Book, which draws on the extensive contacts maintained by regional Fed banks with their local business communities, was prepared in this instance by the Kansas City Federal Reserve, based on data collected on or before Feb. 22.

"Five districts reported that economic growth was moderate in January and early February, and five districts reported that activity expanded at a modest pace," it said. Boston's region expanded slowly and Chicago reported a slow pace of growth.

"This was perhaps a small step down from the previous Beige Book in which all districts reported either modest or moderate growth," said JP Morgan economist Daniel Silver in a note.

FISCAL RESTRAINT

Although consumer spending picked up, retail sales slowed in several districts. Many of the 12 regional Feds pinned the blame on the expiration of a payroll tax holiday in January, higher gasoline prices and the impact of new healthcare laws.

"Many Districts noted rising gasoline prices and fiscal policy as having a negative effect on consumer sales," it said.

Washington is fighting a bitter partisan battle over automatic spending cuts that began to bite on March 1 and could restrain growth by 1.5 percentage points this year. With political gridlock hampering fiscal policy, the central bank has kept the printing presses pumping at full speed.

Fed Chairman Ben Bernanke argued in congressional testimony last week that its aggressive policy actions have had a visible impact on housing and demand for autos, and the Beige Book confirmed that these sectors were perking up.

"Residential real estate markets strengthened in nearly all Districts and home prices rose amid falling inventories across much of the country," it said, while noting that "automobile sales were strong or solid (in) most districts."

The Fed has held interest rates near zero since late 2008 and has tripled the size of its balance sheet to around $3 trillion since then through a controversial bond buying program.

These asset purchases are designed to lower longer-term borrowing costs and the Fed pledges to keep them up until it sees a substantial improvement in the outlook for the U.S. labor market. U.S. unemployment was a lofty 7.9 percent in January.

Critics say bond buying, also called quantitative easing, risks future inflation, but the central bank said there was no sign of higher input prices being passed along to consumers.

"Price pressures remained modest, with the exception of increases in prices for certain raw materials and slightly higher retail prices in several districts," the Fed said. "Even with some input costs rising, most district contacts did not plan to increase selling prices."

On the other hand, while most districts saw a 'modest' improvement in labor market conditions, wage pressures remained limited, although there were some signs of shortages for certain skilled workers, the Fed said.

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