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Fed to end stimulus, but keep watch on low inflation

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After six years of pump-priming a weak economy, the Federal Reserve is expected to take a big step back toward "normal" monetary policy on Wednesday by ending its asset-purchase operations.

[WASHINGTON] After six years of pump-priming a weak economy, the Federal Reserve is expected to take a big step back toward "normal" monetary policy on Wednesday by ending its asset-purchase operations.

But with the global economy frail and low inflation a danger, the Fed is hardly about to tighten the flood of cheap dollars that has propped up growth after the Great Recession.

The Fed has made clear it will not sell off the US$3.5 trillion worth of Treasury bonds and mortgage securities it has accumulated since 2008 in quantitative easing (QE) programs, even though a key goal - bringing down unemployment - has been reached.

Moreover, the policy-making Federal Open Market Committee will stick to its plan to hold its benchmark federal funds interest rate at the zero level well into next year.

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The FOMC has signaled for months its plan to close out the third version of the asset purchase operations, QE3, at the end of its two-day meeting this week, with the announcement expected around 2:00 pm (1800 GMT).

While some analysts think the decision could be held off until December, that would likely serve a more symbolic purpose.

Last December the Fed was pumping US$85 billion a month into the economy via asset purchases to hold down long-term interest rates, to promote lending and investment.

That has been steadily tapered to just US$15 billion in October, and economists say that after six years the impact of QE is less and less - except for helping pump up prices of stocks and other financial assets.

The Fed's principal aim for the policy was to help bring down the unemployment rate, which peaked at 10.0 per cent in October 2009 and fell steadily to 5.9 per cent last month.

With jobs growth now running at a firm clip, the Fed's focus has turned to inflation, which remains well below its 2.0 per cent target.

"The decline in the inflation expectations will undoubtedly take the center stage of FOMC discussions," said BBVA in a client note.

"The focus of the committee's discussion is expected to progress beyond the timing to end QE3. Whether the FOMC ends its US$15 billion large-scale monthly asset purchases in October or December would likely be considered a minor concern." Crucial then is what the FOMC signals for the path of the fed funds rate. The committee has repeatedly stated that the first hike from the 0-0.25 per cent level, where the rate has stood since the end of 2008, will come only "a considerable time" after it ends QE.

Now that the asset purchases are ending, how it adapts that signal will be closely watched. The current expectation is for an initial rate rise in mid-2015.

But, as Fed Chair Janet Yellen repeatedly emphasizes, that depends on what the data says about the strength of economic growth.

AFP

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