Wednesday, June 23, 2010

Fed on sideline, waiting for recovery to firm

WASHINGTON: The Federal Reserve is expected to renew its promise to hold benchmark interest rates exceptionally low for an extended period on Wednesday, June 23 and may acknowledge a slight slowdown in the pace of US economic recovery.

With its decision on borrowing costs not in doubt, financial markets will focus on any softening of the US central bank's characterisation of the solidity of the rebound in a statement expected at about 2.15pm (1815 GMT).

Fed leaders have in recent appearances said they see a steady but gradual recovery. However, disappointing jobs and housing market reports, financial turmoil in Europe, and a four-decade low in a key inflation metric could prompt them to qualify their description of growth.

"We might see more tentative language on the strength of the recovery in the labor market, consumption, housing and financial conditions," said Goldman Sachs chief US economist Jan Hatzius. "Overall, it is debatable whether economic activity continues to 'strengthen,'" as the Fed said in its April statement, he added.

Fed Chairman Ben Bernanke told a congressional panel earlier this month he believes the economy has effectively made the shift to private demand after a period of government-provided life support. Still, he cautioned that "a significant amount of time" would be required to restore the nearly 8 1/2 million jobs that were lost over 2008 and 2009.

The Fed system's own summary of economic conditions around the country found that while they were improving, the pace of growth was modest.

Some Fed officials have said in recent weeks they see the pickup in growth gaining momentum. Kansas City Federal Reserve Bank President Thomas Hoenig has argued the recovery is strong enough, and the risks of inflation from the Fed's easy money policies are serious enough, that raising rates to 1% fairly soon is warranted.

Hoenig has used all three of his votes in 2010 to dissent against maintaining the Fed's low-rates-for-a-long-time promise, arguing rock bottom rates set the stage for another dangerous boom-and-bust cycle.

Bernanke said he expects the world's largest economy to expand at a 3% annualized rate this year and gain steam in 2011. But recent disappointing data have spurred some analysts to question whether the Fed should begin to consider further easing of financial conditions, rather than moving to tighten credit, as has been widely expected would eventually be their next step.

While the economy added jobs in May, most of them were public sector positions. Sales of previously owned homes fell unexpectedly that month.

Financial turmoil in Europe on doubts about euro zone member countries' ability to meet debt obligations roiled financial markets, pushing up interbank lending rates and sparking fears of a renewed credit crunch.

In the United States, bank lending has continued to contract, as banks tighten lending standards and problem commercial property loans on many of their books hold back their ability to lend.

Against that backdrop, consumer prices excluding food and energy rose a scant 0.9% year-on-year through May. Officials would like to see year-on-year core inflation somewhere between 1.5% and 2%.

Excessively low inflation risks setting off a dangerous spiral of restrained spending triggering further price declines. In the early part of the 2000s, the Fed held rates low expressly to guard against the danger of deflation.

With benchmark interest rates in a zero to 0.25% band since December 2008 ' as close to zero as the central bank can effectively get them ' lowering rates is no longer an option.

To counter those possible recovery-spoilers, some analysts think the Fed should consider doing more to stimulate the economy, rather than lay the groundwork for removing its accommodative policies. More asset purchases or other "quantitative easing" to flood the economy with reserves banks can lend would be the only likely course of action.

"The Fed is a long way from tightening monetary policy, BMO Capital Markets Chief Economist Sherry Cooper said. "I wouldn't rule out a resumption of quantitative easing in coming quarters, especially if the fiscal authorities begin to tighten and core inflation dips into negative territory." ' Reuters

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