- 02Nov
(Reuters) - The U.S. Federal Reserve opens a two-day meeting on Tuesday that is expected to conclude with a decision to pump hundreds of billions of dollars into the economy to stir the tepid recovery out of its doldrums.
Policymakers are disappointed with the economy's sluggishness. With an unemployment rate stuck at 9.6 percent and core inflation running at lows not seen since the 1960s, some worry about outright deflation.
They are hoping purchases of U.S. government bonds will further lower borrowing costs and spur more spending. However, many economists -- and some Fed officials -- warn the impact could prove minimal.
"When you get interest rates as low as they are, they can't go much lower, so I don't look for any overpowering results of this action," former Fed Chairman Paul Volcker said.
The Fed cut overnight interest rates to near zero in December 2008 and has already bought about $1.7 trillion in longer-term U.S. government debt and mortgage-linked bonds to lower a range of other borrowing costs.
But Fed officials believe another round of bond purchases, this time focused solely U.S. Treasuries, is warranted to lower unemployment and curb deflation risks.
Analysts expect the U.S. central bank to begin with purchases of about $500 billion of longer-term Treasuries over a six-month period, but leave the buying program open-ended to allow flexibility to ramp or down the operation.
They could also bolster their pledge to keep borrowing costs low until the economy's health is assured.
"While the Fed itself does not know just how much quantitative ease will be required or how long the program will be in effect, we expect enough guidance for markets to form firm views on the stance of monetary policy for a sustained period," said L. Douglas Lee, president of Economics from Washington.
The Fed will announce its decision at around 2:15 p.m. EDT on Wednesday.
Expectations of further Fed easing have already weakened the U.S. dollar. The Australian dollar hit a 28-year high against the greenback on Tuesday after a surprise rate hike from Australia's central bank that underscored the uneven nature of the global recovery.
With the prospect of a long period of ultra-low returns in the United States, investors have flocked to emerging markets, pushing those currencies higher. Emerging economies, worried about asset bubbles and a loss of export competitiveness, have cried foul.
The Bank of Japan, which meets on Thursday and Friday, is also poised to launch a new round of bond buying. The European Central Bank and Bank of England also meet this week, but steady policy is seen.
MISSING THE MARK
The U.S. economy grew at a modest 2 percent annual rate in the third quarter, a bit stronger than in the prior three months but too weak to make a dent in unemployment.
Inflation is well below the Fed's preferred range of between 1.7 percent and 2 percent. In the third quarter, core inflation, which strips out volatile food and energy prices to give a better view of the underlying trend, rose at a 0.8 percent annual rate, the second-slowest pace since 1962.
Dissatisfaction with the recovery is expected to cost majority Democrats dearly in congressional elections on Tuesday. Republicans are expected to win control of the House of Representatives and pick up seats in the Senate.
With 14.8 million Americans unemployed and factories operating well short of full capacity, some Fed officials see the risk of a vicious circle of deferred purchases and falling prices that could choke off economic growth.
Fed Chairman Ben Bernanke laid the groundwork for a further round of bond purchases by arguing the central bank was falling short of its twin objectives -- price stability and full employment.
Further bond purchases, however, are a controversial subject at the central bank and a heated debate is expected on Tuesday and Wednesday.
The Fed owns roughly 12.5 percent of all outstanding Treasury bonds and notes. If it were to buy $1 trillion more, as some economists expect it eventually will, the portion of its holdings compared with all outstanding Treasuries could jump to 27 percent.
Some economists, and some Fed policymakers, worry further purchases could jeopardize the central bank's credibility if the impact proves small. There are also concerns the Fed's bloated balance sheet may set the stage for rampant inflation once the recovery gains traction.
Kansas City Fed President Thomas Hoenig, who is concerned the Fed's easy money policies are prelude to yet another boom and bust cycle, recently said further easing would be "a bargain ... with the devil."
