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Federal Reserve chairman Bank Bernanke (JONATHAN ERNST/REUTERS)
Federal Reserve chairman Bank Bernanke (JONATHAN ERNST/REUTERS)

Fed's less gloomy analysis reduces likelihood of stimulus Add to ...

The Federal Reserve’s policy committee is less glum, a shift that lowers the odds of further monetary stimulus.

The U.S. central bankers released a statement after their latest deliberations Tuesday that said the labour market is improving, the European debt crisis is easing and that higher gasoline prices should cause only a temporary inflation blip.

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That’s as positive as the Fed has been about the economy in a year, a transition that could dull talk of the need for a third multibillion-dollar asset purchase program to lower longer-term interest rates. With borrowing costs already extremely low, Federal Reserve chairman Ben Bernanke has indicated further action will be guided by the evolution of economic data. And for a few months now, the indicators have been getting stronger.

Still, policy makers are far from euphoric. They anticipate only “moderate” growth that will lower the too-high unemployment rate only gradually, and officials describe the housing market as “depressed.” Fed leaders made no changes to their policy Tuesday, restating their intention to leave borrowing costs at exceptionally low levels until at least the end of 2014.

“The unemployment rate has declined notably in recent months but remains elevated,” the policy-making committee said in a statement. “Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook.”

The Fed’s reluctance to endorse a series of positive indicators as proof the U.S. recovery is entrenched will keep alive talk of further stimulus.

However, the case for further measures has been weakened by recent data that show the economy is growing – a fact highlighted by Richmond Fed president Jeffrey Lacker’s dissenting vote on the basis that economic growth is too strong to justify leaving interest rates so low for so long.

Last Friday, a government report showed that the U.S. economy had added more than 200,000 jobs for a third consecutive month in February, only the fourth time that has happened in the last 10 years. On Tuesday, the Commerce Department said retail sales jumped 1.1 per cent in February, the most in five months.

“Household and business fixed investment have continued to advance,” the committee said Tuesday in another shift toward a more positive stance. At its previous meeting in January, its assessment was that business spending had slowed.

“The [committee]is clearly shifting its stance away from blanket gloom to something more realistic, but they have a long way to go,” Ian Shepherdson, chief U.S. economist at High Frequency Economics, said in a note to clients. “The data will force their hand.”

Talk of a third asset purchase program picked up last week after The Wall Street Journal reported that Fed officials were considering creating money to purchase longer-term securities, a strategy that Wall Street economists tend to call quantitative easing. However, the new program would come with a twist. To guard against inflation, the Fed would suck the new money out of the financial system by offering a premium to lend out shorter-dated assets, or by encouraging banks to stash excess deposits with the central bank.

As long as the economy continues to gain strength, new stimulus measures are unlikely. But some analysts predict the current strength in the economy will fade. Even though the unemployment rate is falling, wages are stagnant, suggesting household spending will be muted. Economists at Merrill Lynch foresee trouble in the form of uncertainty associated with the November presidential election and a looming fiscal crunch at year-end, when former president George W. Bush’s tax cuts are scheduled to reset and a massive federal spending cuts are set to begin.

“The market may see today’s statement as the Fed gradually beginning to step away from more QE, but we remain cautious,” Merrill Lynch’s Michael Hanson said in a report. “If our forecast of a second-half slowdown is realized, we would expect the Fed to ease further through QE3 by late summer.”

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