Fed optimistic on rebound

Written on August 27, 2011 – 8:03 am | by Michael Harris

US FEDERAL Reserve Chairman Ben Bernanke said today the central bank stood ready to provide further support to a persistently weak economy, but didnt indicate any move was imminent despite fresh signs of feeble growth.

In a much anticipated speech to global monetary policy makers gathered in Jackson Hole, Wyoming, Dr Bernanke didn’t elaborate on the central bank’s remaining tools to boost the economy, which could have been a sign that the Fed was leaning toward action. Instead, he said the Fed would extend its mid-September policy meeting to two days to discuss options the central bank could pursue.

“The (Federal Open Market) committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability,” Dr Bernanke said.

The latest sign of trouble for the economy came overnight in the US when the Commerce Department revised down its already low estimate for second-quarter growth in gross domestic product. The economy grew by an annual rate of only 1 per cent in the three months to June, not the 1.3 per cent rise that was previously estimated. That was after GDP increased by just 0.4 per cent in the first three months of the year.

Dr Bernanke said the US economic recovery, now more than 2½ years old, continues to be “modest”. Though conceding the pace of growth has been slower than what the Fed expected, he said he expected the economy to pick up some speed in the second half of the year. The Fed chief was also mildly optimistic about the long run, saying the economy hasn’t been permanently scarred by the financial crisis.

“Although important problems certainly exist, the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years,” he told the gathering, which this year focuses on long-term growth prospects for the global economy.

US banks are much healthier now, manufacturing has risen 15 per cent since its trough and households have made progress in repairing their balance sheets, Dr Bernanke said. Still, he warned that financial stress continued to be a significant drag on the recovery both in the US and abroad.

The Fed chairman also pushed the ball back to the government and fiscal policy, and warned that politicians should not reprise their months-long political battle over spending and debt, which he said could “seriously jeopardise” future growth.

“In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow,” Mr Bernanke said.

“Notwithstanding this observation…most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.”

Against deep hopes in markets that he would at least hint that the Federal Reserve would adjust monetary policies to add some fuel to the economy, he stressed that the work would have to be done by politicians using admittedly tightly constrained budgetary resources.

“Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery,” he said.

A recent round of weak data has raised fears the economy may slip into recession again, leading investors to hope Dr Bernanke would use the Kansas City Fed’s annual summer retreat to open the door to a new round of monetary stimulus. A year ago, Dr Bernanke used his Jackson Hole speech to signal the Fed could launch a second round of bond purchases, or quantitative easing, as it eventually did in November.

A changed economic landscape – especially higher inflation – is forcing Dr Bernanke to be more cautious with what would be part three of quantitative easing, or QE3. In August 2010, the economic outlook had deteriorated and inflation was falling. Now, while the economy is still weak, several indicators of inflation remain above the Fed’s informal target of 2 per cent.

Dr Bernanke said he expects inflation to settle at or below a 2 per cent rate following the moderation in the price of oil and other global commodities.

“In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus,” Dr Bernanke said, without reviewing those tools as he did in last year’s Jackson Hole speech.

He didn’t break new ground on whether the Fed would favour extending the maturity of its existing bond holdings or expand it by launching a third round of purchases. Both options would be aimed at lowering long-term interest rates and driving investors into riskier assets like stocks.

The Fed can’t use its traditional lever of pushing short-term interest rates down because they’re already near zero.

At the Fed’s last policy-setting meeting on August 9, the central bank said it intended to keep short-term rates at a record low level until mid-2013 to support the economy.

“Those hoping for more monetary stimulus will be disappointed by Bernanke’s speech,” said Michelle Girard, economist at the Royal Bank of Scotland. “No additional action was announced. No details over possible action were even presented.”

Dr Bernanke said Fed policy can’t do much for the economy’s long-run trend and urged Congress to fix the budget deficit in a way that doesn’t hinder the economy. He said the US needs a better fiscal decision-making progress.

For more than a year, Dr Bernanke has been urging Congress to use government tax and spending policies to provide short-term stimulus to the economy, tied together with a credible plan to bring down the deficit in the long run.

Analysts said Mr Bernanke’s speech had mainly served to put off expectations for another three weeks, giving time to see what economic data shows about growth.

“Bernanke affirmed that policy is not made on the hoof at Jackson but at the FOMC, by adding to the importance of the September meeting, that will now be a two-day meeting discussing alternative tools,” said economist Alan Ruskin of Deutsche Bank.

Harm Bandholz, economist at UniCredit, said the speech showed the Federal Reserve has put its own moves on hold in anticipation that growth will accelerate, negating any need for more stimulus.

“But the risks to the economic outlook are not trivial, and they are primarily skewed to the downside. That means that QE3 is not off the table,” he said.

The US stockmarket eventually interpreted the speech as a positive sign about growth, adding 1 per cent after first plunging because the Fed chief had offered not news of an imminent stimulus package.

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