Fed holds steady on stimulus, worried by fiscal drag

WASHINGTON Wed May 1, 2013 4:20pm EDT

Chairman of the Federal Reserve Bank Ben Bernanke attends the Treasury Department's Financial Stability Oversight Council in Washington April 25, 2013. REUTERS/Gary Cameron

Chairman of the Federal Reserve Bank Ben Bernanke attends the Treasury Department's Financial Stability Oversight Council in Washington April 25, 2013.

Credit: Reuters/Gary Cameron

WASHINGTON (Reuters) - The U.S. Federal Reserve said on Wednesday it will continue buying $85 billion in bonds each month to keep interest rates low and spur growth, and added it would step up purchases if needed to protect the economy.

Expressing concern about a drag from Washington's belt-tightening, the Fed described the economy as expanding moderately in a statement that largely mirrored its last policy announcement in March. Fed officials cited continued improvement in labor market conditions and did not change their description of inflation, saying it should remain at or below the central bank's 2 percent target.

But policymakers reiterated that unemployment is still too high and restated their intention to keep buying assets until the outlook for jobs improves substantially.

"Fiscal policy is restraining economic growth," the U.S. central bank's Federal Open Market Committee said in its policy statement at the close of its two-day meeting. "The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation."

Some economists were surprised that the statement did not contain a clearer acknowledgement of a recent weakening in the economic numbers.

Until recently, analysts had expected the Fed to buy a total of $1 trillion in Treasury and mortgage-backed securities during its ongoing third round of quantitative easing, known as QE3, with expectations the Fed would start to take its foot off the accelerator in the second half of this year.

Now, things are looking a bit more shaky.

"The talk of tapering has not only been pushed to the back burner but pushed off the stove altogether. It's not something we're likely to see until 2014," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.

Wall Street stocks finished close to 1 percent lower after initially paring losses following the Fed statement, and the U.S. dollar weakened in choppy trade.

The president of the Kansas City Fed, Esther George, dissented for a third straight meeting on Wednesday against the Fed's support for growth, citing concerns about financial imbalances and long-term inflation expectations.

Economic growth rebounded in the first quarter after a dismal end to 2012, but the 2.5 percent annual rate of expansion fell short of economists' estimates, and forecasters are already penciling in a weaker second quarter.

The housing market continues to show signs of strength. However, the industrial sector is not quite as perky, with a report on Wednesday showing national factory activity barely grew in April.

And the job market, the focus of much of the Fed's efforts, remains sickly. U.S. employers added only 88,000 workers to their payrolls in March, while private-sector data on Wednesday suggested continued weakness in hiring.

At the same time, inflation has steadily been coming down. The Fed's preferred measure of core inflation, which excludes more volatile food and energy costs, rose just 1.1 percent in the year to March. Overall inflation was up just 1 percent, the smallest gain in 3-1/2 years.

The Fed targets inflation of 2 percent.

CHECKING THE TOOLKIT

In response to a deep financial crisis and recession, the Fed cut overnight interest rates to effectively zero in late 2008. It has also bought over $2.5 trillion in assets, more than tripling its balance sheet, to keep long-term rates low.

If the economy's fortunes do not improve, the central bank may well look for fresh ways to boost its support to the economy, and increasing the amount of assets it is buying is just one option.

The Fed could announce an intent to hold the bonds it has bought until maturity instead of selling them when the time comes to tighten monetary policy. Fed Chairman Ben Bernanke has already raised this as a possibility.

Policymakers could also set a lower unemployment threshold to signal when the time might be ripe to finally raise rates. Currently, the threshold stands at 6.5 percent, provided inflation does not threaten to breach 2.5 percent.

Research suggests such "forward guidance" about the future path of interest rates can have a strong impact on current borrowing costs, and one Fed official -- Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank -- has already suggested lowering the threshold to give the economy a boost.

(Additional reporting by Alister Bull; Editing by Tim Ahmann, Andrea Ricci and Leslie Adler)

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Comments (47)
PapaDisco wrote:
It’s funny how quickly government and the media have come to assume that economic stimulus is solely the province of the Fed. With Congress having abdicated the fiscal stimulus tool, it seems presumed that the Fed can make up the difference with monetary stimulus alone.

May 01, 2013 4:05am EDT  --  Report as abuse
Rhino1 wrote:
http://www.bloomberg.com/news/2013-05-01/fed-seen-slowing-stimulus-with-qe-cut-by-end-of-this-year.html

Curious to see now which one it is ;-)))

May 01, 2013 4:31am EDT  --  Report as abuse
XRayD wrote:
The Fed does not include food and energy in its calculation of the Consumer Price Index because these items are “volatile”.

And, of course, it would not even THINK about stock prices which make new highs in a stagnant economy.

And the Fed ignores its other mandate – “job creation” – with words only and simply treating it as a wish – declare in speeches and papers for nearly five years now like a broken record – “its not as good as we’d like.” Just the way I feel about how much wine and and chocolate ice cream I should consume (because it is not included in the CPI!

The Fed should recognize that robbing savers to the tune of hundreds of billions in interest income on their savings in order to save the Too Big To Fail gambling institutions masquerading as “banks” is NOT the path to job creation. Since the nearly free money to these banks is not being loaned out to businesses or consumers (other than at usurious credit card interest rates) in the real economy, naturally there is and can’t be any inflation. This is a vicious circle without real demand for goods and services. No money for main street, no investment and growth, no jobs, no demand! Imagine if savers were earning $300-$400 Billion in interest as they would under a normal interest rate regime. It would be spent to create demand, not to mention taxes being paid on such interest.

The Fed has no idea IF, WHEN, or HOW it will be able to hang a “MISSION ACCOMPLISHED” banner on its marble facade.

May 01, 2013 5:26am EDT  --  Report as abuse
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