Fed ramps up stimulus, will keep rates near zero

By Pedro da Costa and Alister Bull

WASHINGTON (Reuters) - In an unprecedented step, the Federal Reserve said on Wednesday it would hold interest rates near zero until the U.S. unemployment rate falls to 6.5 percent as it launched a new round of bond purchases to stimulate the economy.

The central bank said its commitment to hold rates steady until its new threshold was reached would hold as long as inflation was projected to be no more than 2.5 percent one or two years ahead and inflation expectations were contained.

Fed officials, who revised their forecasts for economic growth and inflation next year lower, r eplaced a more-modest expiring stimulus program with a fresh round of Treasury debt purchases.

"The committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," the Fed's policy-setting panel said in a statement.

Fed officials committed to monthly purchases of $45 billion in Treasuries on top of the $40 billion per month in mortgage-backed bonds they started buying in September, as financial markets had expected.

Under the "Operation Twist" program that will expire at the end of the month, the Fed was buying $45 billion in longer-term Treasuries with proceeds from the sale and redemption of short-term debt. The new round of government bond-buying it announced on Wednesday will be funded by essentially creating new money, further expanding the Fed's $2.8 trillion balance sheet.

Fed policymakers voted 11-1 to back the new plan. Richmond Federal Reserve Bank President Jeffrey Lacker dissented, as he has at every meeting this year, expressing opposition both to the bond buying and the new economic thresholds.

Stocks added to earlier gains and long-term government bond prices fell on the Fed's announcement.

"They see an anemic economy, and they're doing all they can to get any economic progress," said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio.

In its statement, the Fed noted unemployment remains elevated and that inflation is running somewhat below the central bank's 2 percent objective.

Policymakers repeated a pledge to keep buying bonds until the labor market outlook improved substantially, although they said their long-term asset purchase program would end well before they raise rates.

A drop in the jobless rate to 7.7 percent in November from 7.9 percent in October was driven by workers exiting the labor force, and therefore did not come close to satisfying the employment conditions.

SWEATING A WEAK RECOVERY

The Fed cut overnight rates to near zero in December 2008 and has bought about $2.4 trillion in bonds in a further effort to push borrowing costs lower and spur a stronger recovery.

Despite the unconventional and aggressive efforts, U.S. economic growth remains tepid. GDP grew at a 2.7 percent annual rate in the third quarter, but it now appears to be slowing sharply. According to a Reuters poll published on Wednesday, economists expect the economy to expand at just a 1.2 percent pace in the current quarter.

Businesses have hunkered down, fearful of a tightening of fiscal policy as politicians in Washington wrangle over ways to avoid a $600 billion mix of spending reductions and expiring tax cuts set to take hold at the start of 2013.

Bernanke has warned that running over this "fiscal cliff" would lead the economy into a new recession.

By setting thresholds to help guide its decision on when to eventually hike rates, the Fed was able to jettison a previous prediction that borrowing costs would remain at rock bottom levels until at least mid-2015.

Officials were uncomfortable giving guidance on monetary policy based on a calendar date, and are hopeful the new framework will help financial markets assess incoming economic data in a way that helps them correctly gauge the likely future stance of policy.

Officials emphasized they would look at a broad range of indicators, not just the rates of unemployment and inflation, in determining when to finally raise rates.

"Reaching the thresholds will not immediately trigger a reduction in policy accommodation," Bernanke said at a news conference to explain the Fed's decision. "No single indicator provides a complete assessment of the state of the labor market and therefore we will consider changes to the unemployment rate within the broader context of labor market conditions."

The prior practice of fixing an end point was criticized by some economists as sending a message that the Fed expected the economy to be weak until then.

In a fresh set of economic projections, the Fed suggested the jobless rate would not fall to 6.5 percent until sometime in 2015, and at no point over that forecast horizon does the central bank see inflation topping its 2 percent target.

Officials held to their assessment that they could eventually push the jobless rate down to a 5.2 percent to 6 percent range without sparking inflation, although Bernanke cautioned that policy would have to start tightening before it fell so low.

Officials see GDP expanding between 2.3 percent and 3.0 percent next year, down from the 2.5 percent to 3.0 percent they forecast in September. That's still a bit more optimistic than most private forecasters. The Reuters poll of economists found a median U.S. growth estimate of 2.1 percent for next year on the same fourth quarter over fourth quarter basis.

(Writing by Pedro Nicolaci da Costa; Editing by Andrea Ricci and Tim Ahmann)

Source: http://finance.yahoo.com/news/fed-ramps-stimulus-approach-support-173200191.html

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