June 10, 2009 / 4:44 PM / 10 years ago

UPDATE 2-Fed's Lacker: may not need to boost Treasury buying

(Recasts throughout with Lacker remarks to reporters)

By Alister Bull

RALEIGH, N.C., June 10 (Reuters) - The Federal Reserve should not boost its purchases of U.S. Treasuries because a recent rise in bond yields probably reflects growing optimism on the economy, a top Fed policy-maker said on Wednesday.

“Right now, I don’t see a reason to increase it,” Richmond Federal Reserve President Jeffrey Lacker told reporters, referring to the U.S. central bank’s pledge to buy up to $300 billion of longer-term Treasuries by the autumn.

“In fact, if anything, if yields are rising because of stronger growth that would cut against the case for increasing purchases,” he said after speaking to the North Carolina Senate Appropriations Committee.

The gap between 2- and 10-year U.S. government bond yields has widened to a record 2.75 percentage points in recent weeks and the Fed must diagnose the reason for the shift as it reviews policy options, including Treasury purchases, at its scheduled meeting on June 23-24.

Lacker, who is a voting member of the Fed’s policy-setting committee this year, is one of the most hawkish, or anti-inflation officers of the central bank’s top rank.

Possible explanations include more optimism on growth, which would prompt the Fed to raise interest rates sooner than expected, as well as concerns about massive sales of government bonds to fund a record fiscal deficit, along with inflation and a weaker U.S. dollar.

Lacker, who saw evidence of an improvement in the housing market and an uptick in business sentiment as underscoring hopes for an economic recovery later this year, felt the rise in U.S. Treasury yields was indeed due to hopes for recovery.

“I think improved prospects for real growth are, in my mind, the strongest contender for an explanation for the recent rise in longer rates,” he told reporters.

LOW FOR SOME TIME

The Fed has cut interest rates to almost zero and doubled the size of its balance sheet to around $2 trillion through unconventional measures that include buying Treasuries to fight the most severe recession in a generation.

In his speech to North Carolina’s lawmakers, Lacker stressed the importance of not waiting too long before raising interest rates in case this allowed inflation to take root.

But he emphasized during his discussion with reporters that he still expected the very weak state of the economy to warrant low Fed rates for a while.

“I think growth is likely to warrant rates as low as they are for some time, but just how long is uncertain and hard to predict in advance. We’ll just have to wait to see how the growth process unfolds this year and into next year,” he said.

In his remarks to lawmakers, Lacker said that U.S. unemployment would probably continue to climb even through the recession will have ended and growth be rebounding.

Historically, the Fed has been reluctant to raise rates while unemployment was still heading higher, but Lacker said that this time might be different.

“The reason we have not in the past seen Fed rate increases while unemployment is rising is because rising unemployment tends to be associated with growth that is too low to warrant rate increases. I think the growth process needs to govern our rate decisions,” he said.

This echoed Lacker’s speech where he warned of the risks of waiting too long to raise rates.

“The challenge for us on the Federal Open Market Committee will be to shrink our balance sheet and tighten policy soon Lacker said, referring to the Fed’s policy-setting committee.

He told reporters it would be important to tackle both the balance sheet and interest rate level at the same time.

One of the techniques for reducing the size of the Fed’s balance involves selling Fed bills, which would require congressional approval. Another option under discussion between the Fed and U.S. Treasury is the issuance of Treasury supplementary financing programs.

Lacker said that both options were still on the table, but he did not want to give the Fed power to issue its own debt.

“I worry about the Fed bills proposal. I worry about giving the Fed the ability to use debt finance outside the congressional appropriations process,” he told reporters.

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