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Risks to US economy are eased

Published on Sunday, September 6, 2009 Email To Friend    Print Version

People shop at the low cost, high volume supermarket warehouse Costco on May 16, 2008 in Marina Del Rey, California. (AFP PHOTO)

WASHINGTON (Reuters) - Federal Reserve policy-makers last month believed risks to the U.S. economy had eased “considerably” and discussed stretching out a program that has held down home loan rates.

The Fed expressed confidence the deepest U.S. downturn since the 1930s was ending but also worried about weak growth ahead, according to minutes of its August 11-12 policy session released on Wednesday.

The U.S. central bank decided neither to expand nor contract its economy-supporting purchases of assets after its August confab – a policy balance that could soon tilt toward an “exit strategy” as the economy picks up.

“Meeting participants agreed that the incoming data and anecdotal evidence had strengthened their confidence that the downturn in economic activity was ending and that growth was likely to resume in the second half of the year,” the minutes said.

Still, with the economy poised for a modest recovery at best, officials determined that low interest rates would be needed for an extended period.

“The (Fed) is in no hurry to alter its current policy stance,” Paul Dales, an economist for Capital Economics in Toronto, said in a note to clients. “The Fed will complete its asset-purchasing program and remains reluctant to withdraw its policy support soon.”

Still, Charles Plosser, president of the Philadelphia Fed, warned on Wednesday that the central bank needs to be alert to a potential jump in inflation and could be forced to raise interest rates more rapidly than many pundits expect.

Plosser is a noted inflation hawk whose next vote on the policy-setting Federal Open Market Committee does not come until 2011.

Interviewed on CNBC, Plosser said the U.S. economy should start to grow again in the second half of 2009, with the recovery gaining more traction next year.

Even so, the United States has sustained a possibly permanent shock from the deep recession that started in December 2007, and is likely to grow at a slower rate in the future than had been the case recently, he said.

Lower trend growth could make the economy more vulnerable to rising inflation, complicating the Fed’s policy task.

When it concluded its August meeting, the Fed had said the economy was showing signs of leveling out two years after the onset of the most virulent financial crisis in decades.

At the meeting, the central bank decided to keep benchmark overnight interest rates steady near zero and moved to phase out one of its emergency measures – its $300 billion long-term Treasury buying program. It decided to let that program run several weeks beyond the original mid-September date to smooth the transition in markets.

The minutes showed that policy-makers considered similarly stretching out and tapering off purchases of up to $1.25 trillion in mortgage-backed securities and up to $200 billion in mortgage agency debt, but made no decision. That program, which the Fed launched to drive down mortgage costs, is set to expire at the end of the year.

The Fed’s purchases of mortgage-backed securities have already slowed, and market participants were widely expecting the central bank to stretch the program into next year to wean the market from its support.

So far this year, the Fed has bought $792 billion in mortgage-backed securities and $118.6 billion in mortgage agency debt.

Policy-makers also discussed adding adjustable rate mortgages to fixed-rate mortgages in its mortgage-backed securities buying program to cut costs for some borrowers, but made no decision.

Officials continued to worry the economy remained vulnerable to adverse shocks.

The Fed officials had “particular concern” about weak labor markets and worried that sluggish income growth would hold back consumer spending. One big unknown was the degree to which households have turned more into savers than spenders.

The minutes showed officials also wrestling with the question of whether the unusually low level of interest rates and billions of dollars the Fed has pumped into the economy could eventually spark inflation.

Many officials said they believed that high unemployment and unused factory capacity would keep inflation pressure at bay, while some worried about the risks of deflation, or a broad-based decline in prices.

Others showed more concern about inflation risks and said the public had not reduced its expectations of future inflation by much, suggesting price pressures were still present in the economy.

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