Fed closes cash floodgates as tide turns

WASHINGTON - The Federal Reserve has refrained from pumping more money into the US economy, saying the pace of economic contraction is slowing and predicted inflation will remain "subdued for some time".

After a two-day meeting in Washington, the Fed said yesterday it would not to increase its US$1.75 trillion ($2.7 trillion) bond-purchase programme and kept the benchmark interest rate between zero and 0.25 per cent.

The rate will stay at "exceptionally low levels" for an "extended period", the Federal Open Market Committee said.

Chairman Ben Bernanke is watching to see how quickly the economy can recover from the deepest recession in five decades. Orders for durable goods unexpectedly rose in May, a government report showed yesterday, but unemployment continues to climb.

The Fed also wants to quell concerns that the US$1 trillion expansion in its balance sheet will fuel inflation, pushing bond yields higher and crippling any rebound in the economy.

"The Fed wants to be clear they are not raising rates anytime soon," said John Silvia, chief economist at Wachovia and a former economist in Congress. "They are leaving their options open. The plan is to stay the course at this point in time."

The Fed said "the pace of economic contraction is slowing" and noted "conditions in financial markets have generally improved".

The central bank added that it "is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programmes as warranted."

Total assets on the central bank's balance sheet grew US$1.17 trillion over the past year to US$2.07 trillion as the Fed loaned to banks, commercial paper issuers, and purchased bonds outright to support the flow of credit to consumers and businesses.

"This is a very difficult period," said Marvin Goodfriend, an economist at Carnegie Mellon's Tepper School of Business in Pittsburgh.

"The Fed is exposed to a concern about inflation because it hasn't committed itself to a low-inflation objective, yet the Fed may need the flexibility to expand its balance sheet further if the economy underperforms."

Richard Schlanger, a vice-president at Pioneer Investment Management in Boston, said: "Looking back, we are all cognisant of what transpired in 2003 and 2004 when the Greenspan Fed just left the federal funds rate too low for too long."

Bernanke succeeded Alan Greenspan at the Fed's helm in February 2006.

Bernanke told Congress in June that the Fed "will not monetise" US debt, addressing concern that the central bank's purchases of government debt might be used to finance deficit spending. Measures of overall inflation retreated in April while so-called core prices rose.

Fed officials revised their estimates for growth, unemployment and inflation at yesterday's meeting. Their new forecasts will be available when the Fed publishes meeting minutes next month.

Private forecasters expect the economy to grow 1.9 per cent next year, with inflation at 1.8 per cent, according to the median estimates in a Bloomberg News survey.

The unemployment rate will rise further, averaging 9.7 per cent for 2010, according to economists in the survey. The jobless rate stood at 9.4 per cent in May, the highest since 1983.

- BLOOMBERG