* Fed expected to maintain $85 bln/month in bond buys
* Central bank seen nodding to soft economic signs
* Debate could turn toward doing more, not less
By Pedro Nicolaci da Costa
WASHINGTON, May 1 The Federal Reserve's debate
over U.S. monetary policy could begin to shift away from the
prospect of reducing stimulus toward a discussion about doing
more, given the signs of economic weakness and slowing
But policymakers are not there yet.
At a two-day meeting that wraps up on Wednesday, the Fed is
widely expected to maintain its monthly purchases of $85 billion
in bonds to support an economic recovery that is nearly four
years old but still too weak for the job market to truly heal.
With the central bank's favored inflation gauge slipping and
employment growth faltering, Fed officials could again find
themselves in the uncomfortable position of having to shift from
talk of curbing stimulus to the possibility of doing more.
Currently, analysts see the Fed buying a total $1 trillion
in Treasury and mortgage-backed securities during the ongoing
third round of quantitative easing, known as QE3. Until
recently, analysts had believed the Fed would start taking the
foot off the accelerator in the second half of the year.
Now, things are looking a bit more shaky.
The housing market continues to show signs of strength, with
home prices posting their biggest yearly gain since 2006, the
year the market began a historic slide that snowballed into a
global financial crisis.
However, the industrial sector is not quite as perky.
Durable goods orders posted their largest drop in seven months
in March, while an index of Midwest manufacturing showed an
unexpected contraction in the sector for April.
Economic growth did rebound 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 economists are already
penciling in a weaker second quarter.
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
Despite the economy's softer tone, a wait-and-see attitude
seems the most likely approach for now. The Fed is expected to
nod to the economy's disappointing performance when it announces
its decision at 2 p.m. (1800 GMT), even as it maintains its
But if the economy's fortunes do not improve, the U.S.
central bank may well look for fresh ways to boost its support
to the economy -- 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.
U.S. central bankers could also set a lower unemployment
threshold to signal when the time might be ripe to finally raise
overnight interest rates, which they have held near zero since
December 2008. 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.
"Forward guidance would be perceived as having lower costs
(than bond purchases) by most, I think, and for that reason I
think it could be the preferred avenue, especially if more
stimulus was projected to be needed for a long period of time,"
said Roberto Perli, a partner at Cornerstone Macro in Washington
and a former Fed economist.
Analysts generally agree that is a debate for the future, if
the Fed even gets there at all.
Victor Li, a former regional Fed economist who teaches at
Villanova University in Pennsylvania, said employment growth
would have to be consistently below the 100,000 jobs per month
pace in combination with core inflation of around 1 percent for
the Fed to consider a greater easing of monetary policy.
"There is just no evidence that this is going to happen."
Others are less sanguine. Justin Wolfers, an economics
professor at the University of Michigan's Gerald Ford School of
Public Policy, said the risk that prices will drop persistently,
causing further economic damage, cannot be ruled out.
"What's more relevant than the current inflation trend is
what this means for forecast inflation," Wolfers said. "And I
think even more relevant than the Fed's official point estimate
for inflation is the probability that deflation looms as a real
threat. Inflation rates lower than 1 percent certainly raise a
greater risk of deflation."