Fed ties rates to jobs recovery, adds to stimulus

WASHINGTON (Reuters) - The U.S. Federal Reserve, announcing a new round of monetary stimulus, took the unprecedented step on Wednesday of indicating interest rates would remain near zero until unemployment falls to at least 6.5 percent.

It was the latest in a series of unorthodox measures taken by central banks around the world to battle erratic, sub-par recoveries from the financial crisis and recession of 2007-2009.

The Fed expects to hold rates steady until its new threshold on unemployment was reached as long as inflation does not threaten to break above 2.5 percent and inflation expectations are contained. It also replaced an expiring stimulus program with a fresh round of Treasury debt purchases.

The central bank previously said it expected to hold rates near zero through at least mid-2015, but policymakers were uncomfortable making a pledge based on the calendar rather than the economic goals they hope to achieve.

"By tying future monetary policy more explicitly to economic conditions, this formulation of our policy guidance should ... make monetary policy more transparent and predictable to the public," Fed Chairman Ben Bernanke told a news conference.

Importantly, in the eyes of Fed officials, the new framework should help financial markets assess incoming data in a way that helps them better guess were monetary policy is heading.

Right now, the Fed is engaged in an open-ended program of asset purchases, which it bolstered on Wednesday.

Officials committed to buy $45 billion in longer-term Treasuries each month on top of the $40 billion per month in mortgage-backed bonds they started purchasing in September. They repeated a pledge to keep pumping money into the economy until the outlook for the labor market improves "substantially."

"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 after a two-day meeting.

BALANCE SHEET ACTION

The Fed will fund the new Treasury purchases with an expansion of its $2.8 trillion balance sheet. Under the expiring "Operation Twist" program, the Fed bought an identical amount, but paid for them with proceeds from sales and redemptions of short-term debt.

Some policymakers view actions that expand the Fed's balance sheet as economically more potent than actions that do not. However, Bernanke said the dose of stimulus would remain about the same, given that the central bank is still purchasing a combined $85 billion per month in longer-term securities.

"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.

The Fed's decision initially gave a small lift to U.S. stock prices, but the major indexes closed mostly unchanged, while government bond prices fell. Oil prices rose and the dollar weakened against the euro.

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

SWEATING A WEAK RECOVERY

The newly unveiled numerical policy guidelines offered the most specific suggestion yet that the Fed is willing to tolerate slightly higher inflation as it tries to juice up a moribund economy and spur stronger job growth.

A drop in the unemployment 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 condition the Fed has set for trimming its stimulus.

In response to the financial crisis and recession, the Fed slashed overnight rates to zero almost exactly four years ago and bought some $2.4 trillion in mortgage and Treasury securities to keep long-term rates down.

Despite its unconventional and aggressive efforts, U.S. economic growth remains tepid. Gross domestic product grew at a 2.7 percent annual rate in the third quarter, but a Reuters poll published on Wednesday showed economists expect it 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 to a new recession. He told reporters the Fed could ramp up its bond buying "a bit," but emphasized that monetary policy has limits and could not fully offset the impact.

NEW TACK ON RATES

He said the central bank would look at a range of indicators, not just the rates of unemployment and inflation, in determining when to finally push overnight borrowing costs higher, adding that the Fed was not on "auto pilot."

"Reaching the thresholds will not immediately trigger a reduction in policy accommodation," Bernanke said. "No single indicator provides a complete assessment of the state of the labor market."

Bernanke said the new framework was consistent with the earlier calendar guidance, because officials do not expect the jobless rate to reach 6.5 percent until sometime in 2015.

Indeed, a fresh set of economic projections from the Fed put the rate in a 6 percent to 6.6 percent range in the fourth quarter of 2015. At the same time, the projections showed that 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 unemployment 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. In its statement, the Fed said its long-term asset purchase program would end well before any rate increase.

Fed policymakers see GDP expanding between 2.3 percent and 3.0 percent next year. That is down from the 2.5 percent to 3.0 percent they forecast in September, but is 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.

(Writing by Pedro Nicolaci da Costa; Editing by Andrea Ricci, Tim Ahmann, Leslie Adler and Andre Grenon)

Source: http://news.yahoo.com/fed-ties-rate-pledge-threshold-stimulus-set-001338283--business.html

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