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Weak outlook prompts Fed to push for borrowing

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By Martin Crutsinger
Associated Press
Published:
WASHINGTON -- The Federal Reserve is trying again to jolt the American economy out of its stalled recovery. It's extending a program that aims to encourage borrowing and spending by reducing long-term interest rates.
Wednesday's decision followed months of concern that the economy is being held back by a weakened job market.
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.
"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 wasn't impressed by the Fed's limited response. 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 likely suffer.
Bernanke noted that the economy is under threat from Europe's debt crisis and the prospect of sharp spending cuts and tax increases that would take effect at the end of the year unless Congress acts.
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.
Jones estimates Operation Twist will lower long-term rates by only about one-tenth of a percentage point.
At his quarterly news conference later Wednesday, 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.
The yields on Treasury bonds finished the day slightly below where they were before the announcement. The Dow Jones industrial average finished down about 13 points.
John Canally, investment strategist at LPL Financial, says the Fed delivered just what investors expected and offered a hint at further easing.
"If there's another misstep somewhere -- in Europe ... more weak data -- the Fed's going to do more," Canally said.
For now, he said, the Fed wants to keep "some powder dry" in case there's a meltdown in Europe. Canally also suggested that the Fed may be reluctant to be aggressive in an election year out of concern it could be seen as affecting the election.
But in a comment on Twitter, Justin Wolfers, an economics professor at the University of Pennsylvania's Wharton Business School, suggested that the Fed might be on the cusp of going further.
Wolfers characterized their view as: "One more bad jobs report and we'll do more."
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. And the central bank now thinks the unemployment rate, currently at 8.2 percent, won't fall much further in 2012.
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.
One positive trend is that U.S. inflation is low. Core consumer prices, which exclude volatile food and energy costs, have risen just 2.3 percent over the past 12 months. That's near the Fed's 2 percent target for inflation.
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.
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.
Story tags » Financial & Business ServicesJobsSmall business

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