Fed takes modest action on rates, even as forecast dims
Washington • Trying again to jolt the American economy out of its stalled recovery, the Federal Reserve is extending a program that aims to encourage borrowing and spending by reducing long-term interest rates.
The modest action reflects growing concern that the economy once again is stumbling into the summer months after the false promise of a relatively strong winter. The Fed now expects the unemployment rate to fall no lower than 8 percent this year, and inflation to rise no higher than 1.7 percent, both signs of an ailing economy.
Fed officials also have indicated a desire to insure against a pair of looming risks, that events in Europe will freeze global financial markets and that the political stalemate in Washington over fiscal policy will undermine the domestic recovery.
But the program extension does not appear large enough to boost growth significantly. Instead, it amounts to a placeholder, an effort to soothe markets and preserve the status quo while the Fed seeks greater clarity about the health of the economy, economists said.
At the end of a two-day policy meeting, the Fed also sharply reduced its forecast for U.S. growth and said it's prepared to take more action if necessary. It reiterated plans to keep short-term interest rates at record lows until at least late 2014.
The Fed now thinks the economy will grow no more than 2.4 percent this year. That compares with its forecast in April that the economy could grow up to 2.9 percent.
"If we're not seeing a sustained improvement in the labor market, that would require additional action," Fed Chairman Ben Bernanke said later in the day.
Wall Street in general wasn't impressed Wednesday by the Fed's limited response, after the Dow rose by triple digits the day before in anticipation of more direct action. Stock prices barely budged. And analysts questioned how much benefit the Fed's latest economy-boosting effort would have, in part because interest rates are already near record lows.
If the Fed's more pessimistic outlook proves accurate, President Barack Obama's chances in an election that will turn on the economy would also probably suffer.
European leaders will be seeking a breakthrough at a summit next week in Brussels. Bernanke said he's in regular touch with the head of the European Central Bank.
The Fed said it will continue a program called Operation Twist through year's end. Under the program, the Fed has been selling $400 billion in short-term Treasurys since September and buying longer-term Treasurys. Operation Twist was to expire at the end of June. The Fed said it will extend it using $267 billion in securities.
But extending Operation Twist might not provide much benefit. Businesses and consumers who aren't borrowing now aren't that likely to change their minds just because rates dropped a little more.
"This move is largely symbolic," said David Jones, chief economist at DMJ Advisors. He estimates Operation Twist will lower long-term rates by only about one-tenth of a percentage point.
"It will do very little to boost growth, but the Fed clearly wants to be seen to be doing something," Ian Shepherdson, chief U.S. economist at High Frequency Economics, wrote in a note to clients shortly after the decision was announced.
It is the first time since January that the Fed has intensified its efforts to revive economic growth, and the first time since September that the Fed has announced a new round of asset purchases. This is the fifth such announcement since 2008. In total, the Fed has purchased well more than $3 trillion in securities.
At his news conference, Bernanke said the Fed would consider more aggressive action, such as another bond-buying program. The Fed has completed two such programs. It bought more than $2 trillion in Treasurys and mortgage-backed securities, expanding its portfolio above $2.8 trillion.
Critics have complained about the Fed's efforts to boost growth over the past three years by purchasing more than $2 trillion in bonds. They say the extra money added to the banking system could ignite inflation once the economy rebounds.
In its statement, the Fed noted that oil and gas prices have fallen. Lower prices give the Fed room to take further action without igniting inflation.
The Fed's statement was approved on an 11-1 vote. Jeffery Lacker, president of the Richmond Regional Fed Bank, dissented for the fourth straight meeting. The statement said he opposed the continuation of Operation Twist.
Josh Feinman, global chief economist at DB Advisors, said the extension of Operation Twist allows the Fed to do something without expanding its portfolio of securities. Launching a new bond-buying program would have likely incited criticism that the Fed was escalating the long-term risks to the economy.
In part, that's because the Fed would eventually find it harder to shrink its portfolio without driving interest rates back up and possibly threatening the economy.
"The downside risks have increased enough that they felt they needed to do something," Feinman said. "Extending Operation Twist was the path of least resistance."
The U.S. economy looks weaker than it did when the Fed last met in April. Growth was more sluggish in the first three months of the year than first estimated.
Job growth averaged only 73,000 in April and May, after average gains of 226,000 a month in the first three months of the year.
The number of people seeking unemployment benefits has risen about 5 percent in the past six weeks. And employers posted sharply fewer job openings in April compared with the previous month.
Economists also worry the debt crisis in Europe is worsening, even after Greek election results increased the likelihood that Greece will stay in the euro currency alliance.
This week's Fed meeting was the first time that the Fed board has been at full strength in six years. Jeremy Stein, a Harvard economics professor, and Jerome Powell, a former private equity executive, attended their first policy meeting since being confirmed by the Senate last month.