Fed expected to hold steady to support fragile recovery

Fed expected to hold steady to support fragile recovery

Washington: Federal Reserve policymakers may formally acknowledge an economic recovery is under way but will make few changes to their vast stimulus effort until they see a sustainable expansion, analysts say.

A two-day meeting of the Federal Open Market Committee opening on Tuesday is widely expected to leave unchanged the US central bank’s near-zero interest rate policy while making only minor changes to the array of liquidity programmes to keep credit flowing.

Fed chairman Ben Bernanke said last Tuesday the US recession “is very likely over" but that the economy remains weak due to difficult credit conditions and high unemployment.

John Ryding, chief economist at RDQ Economics, said the Fed cannot even think about hiking rates with the current degree of economic slack and joblessness.

“With so much slack in the economy, the Fed is not going to be inclined to raise rates anytime soon," Ryding said.

“At the same time (year-over-year) inflation rates are still in negative territory. They can be relieved the recovery is more clearly here and acknowledge it but there is no reason for the Fed to do anything different."

With the federal fund rate seemingly frozen at 0-0.25%, the central bank’s only policy option revolves around its various liquidity programmes implemented since last year’s credit freeze.

The Fed last month indicated it would conclude its $300 billion programme to purchase treasury bonds, part of a programme to bring down interest rates which some call “quantitative easing".

It must decide, however, on whether to extend into 2010 a trillion-dollar programme to purchase mortgage securities, which is aimed at keeping credit flowing to the still-weak housing market.

Scott Brown, chief economist at Raymond James and Associates, said the Fed may make some modest changes in these special programmes as it positions itself for a strengthening economy.

“They are in no hurry to start raising short-term interest rates but they do have to keep an eye on the end game," he said.

This may mean “a little tough talk on inflation" and some “tapering off" of liquidity efforts, he said.

The Fed has already indicated it has scaled back its commercial paper guarantee programme and currency swaps with other central banks because credit markets are operating more normally.

The Fed meeting comes just ahead of a summit of the Group of 20 wealthy and developed nations expected to discuss the winding down of stimulus measures as the global economy moves towards recovery.

The US gross domestic product (GDP), the broadest measure of the economy’s activity, fell at an annualized rate of 1% in the second quarter, after a 6.4% plunge in the January-March period.

But unemployment rose in August to a 26-year high of 9.7% and there is a growing fear joblessness may hit 10% before a full recovery takes root.

Dean Maki, economist at Barclays Capital, said the job of the Fed and other central banks will become more complicated as the recovery progresses.

“Central banks around the world slashed interest rates and together with fiscal policy stimulus in many countries, these actions helped the global economy escape recession," he said. “With this part of the mission accomplished, we think the focus of central banks will be shifting, but at different speeds."

Maki argues that the US recovery is gaining more steam than most analysts expect and now calls for a robust 5% growth pace by the first quarter of 2010.

Based on historical data, Maki said that “the strength of a recovery has been proportional to the depth of the recession" and added: “By that standard, our peak quarter of 5% growth can actually be thought of as conservative."

Maki said the Fed in the coming week will likely trim its debt purchases to acknowledge the normalization of credit markets but will maintain ultra-low rates to keep the recovery on track for another year.