Fed holds firm to stimulus plan despite brighter economy

Washington: The US Federal Reserve (Fed) on Wednesday pressed forward with its aggressive efforts to stimulate the US economy, saying it would take into account risks posed by its policies, but also how much work still needs to be done to lower unemployment.

Meeting just as turmoil in Europe took another turn for the worse, the central bank nodded to brighter economic signs in the US. But the Fed dropped a reference from its last policy statement that global financial strains were easing, and noted the headwinds from tighter fiscal policy in Washington.

The decision by the Fed’s policy-setting committee to continue to buy $85 billion in mortgage and Treasury bonds per month came despite growing concerns from some officials about the risks the purchases could pose, including possible disruptions to financial markets and future inflation.

“These costs remain manageable but will continue to be monitored, and we will take them into appropriate account as we determine the size pace and composition of our asset purchases,” Fed chairman Ben Bernanke told reporters after the central bank’s decision.

“When we see that the (labour market) situation has changed in a meaningful way, we may well adjust the pace of purchases,” he added.

Fed officials said the world’s largest economy had returned to moderate growth after a pause in the fourth quarter of last year. They also noted positive, if insufficient, strides in the labour market.

“The housing sector has strengthened further, but fiscal policy has become more restrictive,” the Fed said. It said it “continues to see downside risks to the economic outlook.”

Esther George of the Kansas City Fed again was the sole dissenter against the decision. She expressed concern the asset purchases could lead to financial imbalances and inflation.

US stocks rose after the statement was released, while the dollar hit a session high versus the Japanese yen. Prices for US Treasury debt dropped.

“The Fed still is in a very dovish mode and I do not expect to see them remove policy accommodation any time soon,” said Eric Stein, co-director of global income at Eaton Vance Management in Boston.

Minor forecast shifts

The Fed also released a new set of forecasts that showed only minor shifts in the expectations of policymakers.

Fed officials now see growth in a range of 2.3-2.8% in 2013, down from 2.3-3% in its December projections—a likely acknowledgment of the tightening of US fiscal policy.

For 2014, the Fed sees US gross domestic product expanding 2.9-3.4% versus 3.0-3.5% in December.

At the same time, estimates for the unemployment rate were also lowered slightly, even if they remained too high for most policymakers’ comfort. The Fed now believes the jobless rate, which registered 7.7% in February, will average 7.3-7.5% in the fourth quarter of this year.

However, the unemployment rate will not fall to 6.5%, the level at which the Fed says it will begin to consider raising interest rates, until 2015, the estimates indicate.

One key indicator that bolstered confidence in the US recovery was a February employment report showing a 0.2 percentage point drop in the jobless rate and the creation of 236,000 net new jobs.

If that pace of job growth can be sustained for a few months, the Fed might be able to claim substantial progress has been made toward an improved employment outlook—its own stated prerequisite for the cessation of bond buys.

Developments in Cyprus, where the prospect of a tax on bank deposits to help fund the country’s bailout sent jitters through the global financial system earlier this week, likely reinforced the resolve of Fed officials to bolster the US economy. The levy was rejected in parliament, leaving the financial rescue in disarray.

Bernanke called the situation in Cyprus “difficult” because the country faces fiscal and bank capitalization issues, as well as political stress.

“It does have some consequence,” he said. “But having said that, the vote failed and the markets are up today, and I don’t think the impact has been enormous.”

A Reuters poll published a week ago found economists expect the Fed’s current bond purchase plan eventually to total $1 trillion, though many see the central bank easing off on the pace of buying toward the end of the year. Analysts also see a large gap, potentially one or two years, between the time the Fed stops buying bonds and when it begins raising rates.

Global concerns aside, the Fed has plenty of reasons not to begin pulling back on stimulus yet. Its preferred measure of inflation continues to run below the Fed’s 2% target and unemployment remains far above its pre-recession levels.

The Fed cut benchmark overnight rates effectively to zero in 2008 as it battled the financial crisis. It has also bought more than $2.5 trillion in Treasury and mortgage bonds to keep long-term borrowing costs low to spur consumption and investment.

Since December, the central bank has said it would keep rates near zero until the jobless rate falls to 6.5% as long as inflation did not threaten to pierce 2.5% over a one- to two-year horizon—a commitment it reiterated on Wednesday. The Fed also restated a vow to keep policy loose even as the recovery picks up. 

 

 

 AMIT KUMAR SINGH

PGDM 2ND SEM............