Fed to hold course on stimulus despite debate over risks

By Pedro Nicolaci da Costa

WASHINGTON (Reuters) - Federal Reserve officials will spend much of a meeting next week debating the potential risks from the central bank's stimulus plan, but Chairman Ben Bernanke has already signaled he believes the costs of inaction are even greater.

The U.S. central bank looks set to keep buying $85 billion a month in mortgage and Treasury bonds in an effort to encourage investment and bolster a weak economic recovery.

A raft of recent data, from retail sales and manufacturing to employment, has shown the economy gathering some steam. Still, the unemployment rate remains uncomfortably high at 7.7 percent, while low inflation makes policymakers comfortable that there is plenty of room to let the economy run.

"In light of the moderate pace of the recovery and the continued high level of economic slack, dialing back accommodation with the goal of deterring excessive risk-taking in some areas poses its own risks to growth, price stability, and, ultimately, financial stability," Bernanke said on March 1.

The U.S. central bank will likely nod to the improving economic backdrop when it issues a statement at 2 p.m. (1800 GMT) on Wednesday at the end of its two-day meeting. In forecasts accompanying the statement, it is expected to bump up projections for economic growth and lower predictions for unemployment.

However, it is also likely to renew its commitment to keep buying bonds until the employment outlook improves substantially. A Reuters poll published on Wednesday found economists look for the Fed to keep buying bonds for the rest of the year, taking total purchases in its third round of quantitative easing to $1 trillion.

It is a prospect that is not without opposition within the central bank. A number of Fed officials have become increasingly vocal about the program's potential side effects, including the possibility of financial instability, asset bubbles or future inflation.

The Fed cut overnight interest rates to near zero in December 2008. It has already bought more than $2.5 trillion in bonds, bloating its balance sheet to more than $3 trillion.

"I would like the (Fed) to begin to taper these purchases with an aim toward ending them before the end of the year," Philadelphia Federal Reserve Bank President Charles Plosser said last week.

"We are trying to be easier and easier and easier," he said. "I think we need to just stop and have some patience."

GAUGING THE ECONOMY'S PROGRESS

Bernanke told Congress last month that the central bank is taking the concerns of Plosser and other officials seriously, and policymakers plan to review the efficacy and costs of the program next week with fresh analysis pulled together by staff.

It will fall to Bernanke, who will hold a news conference at 2:30 p.m. (1830 GMT) on Wednesday, to make sure the concerns expressed by Fed hawks do not scare investors into believing an end to bond purchases is imminent.

"I get the sense that the Fed's attempts to measure the costs are not turning up anything very large," said Joseph Gagnon, a former Fed economist now at the Peterson Institute in Washington.

Right now, the U.S. stock market sees the economy as being in a sweet spot: Things are improving, but are not so hot as to lead the Fed to pare back its support. That optimism helped lift the Dow Jones industrial average <.dji> for a 10th straight day on Thursday, the longest string of gains since late 1996. The Dow closed at yet another record high, while the S&P 500 <.spx> came within 2 points of its lifetime peak set in 2007.

The U.S. economy created 236,000 jobs last month. That was a positive surprise. But Fed officials are all too aware that the economy still needs another 3 million or so jobs just to get back to its pre-recession levels - and that's not accounting for population growth.

The Fed has vowed to keep official short-term interest rates near zero until the jobless rate falls to 6.5 percent, as long as inflation is not estimated to rise above 2.5 percent.

The majority of economists in the Reuters poll believe the jobless rate threshold will not be reached until at least the second half of 2015. The survey also showed economists expect a large gap, of potentially more than a year, between the end of asset purchases and the first rate rise.

"Fed officials will want to reassure market participants that tightening soon is not in the cards," said Vincent Reinhart, economist at Morgan Stanley and a former Fed staffer.

(Reporting by Pedro Nicolaci da Costa; Editing by Tim Ahmann and Jan Paschal)

Source: http://news.yahoo.com/fed-hold-course-stimulus-despite-debate-over-risks-050607362--business.html

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