Fed bets big to rescue US economy

PEDRO DA COSTA AND ALISTER BULL
Last updated 08:24 14/09/2012

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The US Federal Reserve launched another aggressive stimulus programme on Thursday, saying it will buy US$40 billion (NZ$48b) of mortgage-backed debt per month until the outlook for jobs improves substantially as long as inflation remains contained.

In an unprecedented step, the Fed's policymaking panel escalated its effort to drive US unemployment lower by tying its unconventional bond buying directly to economic conditions, a move that immediately sparked controversy among its critics.

"If the outlook for the labour market does not improve substantially, the committee will continue its purchase of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability," the Fed said in a statement.

In an additional move that reflects just how concerned Fed officials are about the economy, officials said they were not likely to raise interest rates from current rock-bottom lows until at least mid-2015. Previously, it had set such guidance at late 2014.

"To support continued progress toward maximum employment and price stability, the committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens," the central bank said.

US stocks added to gains on the Fed's move, the dollar fell broadly, oil prices rose and gold hit a six-month high. However, bond prices dropped as some investors worried the aggressive easing of monetary policy might fuel inflation.

"They are definitely stepping up," said William Larkin, a portfolio manager at Cabot Money Management in Salem, Massachusetts. "It creates an inflation outlook concern because if you are doing it for this extreme for this length of time, my biggest question is what is going to happen to inflation in two years?"

PUSHING ON A STRING?
The decision comes in the face of widespread questions about the likely effectiveness of a further foray into unorthodox monetary policy, including from Republican presidential nominee Mitt Romney.

Senator John Cornyn, head of the Senate Republican Campaign Committee, said the Fed appeared to be "trying to juice the economy" ahead of the November 6 presidential election to help Obama. "It looks to be political," he said.

Brazilian Finance Minister Guido Mantega said he would keep a close eye on the impact of the Fed's monetary easing on Brazil's real currency. Mantega had accused the Fed's earlier bond buying of unfairly weakening the US dollar.

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In its statement, the Fed said the fresh MBS purchases, which it will start on Friday, would come on top of its so-called Operation Twist programme, in which it is selling short-term bonds to buy longer-term Treasury debt.

"These actions, which together will increase the committee's holdings of longer-term securities by about US$85b each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and to help make broader financial conditions more accommodative," it said.

The latest purchases build on the US$2.3 trillion in US government and housing-related debt the Fed has already bought.

In the Fed's first two rounds of so-called quantitative easing, dubbed QE1 and QE2, the central bank bought bonds closer to a pace around US$100 billion per month.

"SWALLOWING THE KEY"
By buying mortgage-linked debt, the Fed hopes to press mortgage costs lower and force investors into other assets, lowering their yields as well. Those lower borrowing costs should spur greater lending activity and foster faster economic growth, officials believe.

US economic growth cooled in the second quarter, coming in at a tepid 1.7 per cent annual rate, and forecasters do not believe it is doing much better now.

The economy created just 96,000 jobs last month, less than needed to keep up with population growth. While the unemployment rate edged down to 8.1 per cent, it was only because so many Americans gave up on the search for work.

A summary of policy-makers' individual projections released after the statement showed that 12 of the 19 members of the committee think that the first upward move in rates should occur in 2015, twice as many as had in June.

One policymaker thought rates should stay near zero until 2016 while, mirroring the wide division of views currently on the committee, six officials believed policy should start to tighten some time between now and the end of 2014. The projections do not identify individual policymakers.

In a reflection of optimism over their new policy path, officials lowered their forecast for the unemployment rate at the end of 2014 to a 6. 7 per cent to 7.3 per cent range, down from a June range of 7.0 per cent to 7.7 per cent. Still, even in 2015, they believe the jobless rate will still be above where they eventually want it to settle.

Stephen Stanley, an economist Pierpont Securities in Stamford, Connecticut, said that by tying its purchases to progress reducing US unemployment, the Fed had "basically locked on the handcuffs and swallowed the key."

- Reuters

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