Fed's George: Slowing bond buying appropriate next step for Fed

SANTA FE, New Mexico Tue Jun 4, 2013 4:00pm EDT

SANTA FE, New Mexico (Reuters) - Slowing the pace of Federal Reserve bond buying would not mean tightening U.S. monetary policy and would help wean financial markets off their dependence on ultra-easy money from the U.S. central bank, one of its senior officials said on Tuesday.

Kansas City Fed President Esther George, who said she supports slowing the pace of purchases as an "appropriate next step for monetary policy", has been a steady critic of the program and has voted against it at every Fed meeting so far this year.

"History suggests that waiting too long to acknowledge the economy's progress and prepare markets for more normal policy settings carries no less risk than tightening too soon," she said in remarks that she had been scheduled to deliver at a luncheon here, but was unable to because she felt unwell.

Financial markets are on red alert for signs the Fed might scale back buying from a current $85 billion monthly pace after Fed Chairman Ben Bernanke told Congress on May 22 that it could adjust them down over the next few meetings, provided the economy continued to strengthen.

"A slowing in the pace of purchases could be viewed as applying less pressure to the gas pedal, rather than stepping on the brake. Adjustments today can take a measured pace as the economy's progress unfolds," she said in the speech.

George, viewed as one of the central bank's more hawkish policymakers, has been arguing for such a move for months.

She has dissented at every policy meeting since January out of concern that its ultra-aggressive stimulus risks financial instability and future inflation.

The Fed has held interest rates near zero since late 2008 and more than tripled the size of its balance sheet to around $3.3 trillion to hold down longer term borrowing costs and boost U.S. growth and hiring after a severe 2007-09 recession.

In the speech, George continued to highlight the risk that flooding banks with excess reserves via bond purchases could lead investors to shift into riskier assets to replace the yield they are no longer earning on safer assets. Critics warn this could fuel the next financial bubble, which would plunge the nation back into recession when it eventually burst.

For evidence, George noted debit balances on security margin accounts hit an all-time high in April, a sign investors were borrowing at very low rates to purchase riskier assets, and the reach for yield had pushed investors into leverage loans, which package together high-risk commercial loans.

She has previously drawn attention to rising agricultural land prices as another example.

Moreover, George voiced concern that the market had come to regard the Fed's aggressive actions as "conventional".

"As a result, several sectors in the economy are becoming increasingly dependent on near-zero short term interest rates and quantitative easing policies," she said.

This was unhealthy, she said, and could lead to credit misallocation, with investors pushing too much capital into a sector of the economy that would ultimately prove to be less rewarding than expected, doing wide harm to the nation.

That happened to the U.S. housing market, when speculators bet house prices would keep rising, sparking a global financial crisis and pushing U.S. unemployment above 10 percent as growth collapsed.

Slowing bond purchases would help to prevent that happening again.

"It would importantly begin to lay the groundwork for a period when markets can prepare to function in a way that is far less dependent on central bank actions and allow them to resume their most essential roles of price discovery and resource allocation," she said in her prepared remarks.

(Reporting by Alister Bull, editing by Chizu Nomiyama)

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