Fed Sees Risk of Disinflation, Maintains Bond Buying Pace

The Federal Reserve said persistently low inflation could hamper the economic expansion and pledged to keep buying $85 billion in bonds every month.

“The committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term,” the Federal Open Market Committee said today after a two-day meeting in Washington. Growth will “pick up from its recent pace.”

Chairman Ben S. Bernanke and his colleagues cited “further improvements” in the labor market, while saying economic growth was “modest” and not indicating the timing for a trim to bond purchases. They are debating whether the economy is strong enough to warrant scaling back stimulus even as the jobless rate persists at 7.6 percent and inflation through May was well below their longer-run target of 2 percent.

“They’re reiterating their expectations that economic growth is going to pick up,” said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock Inc., which manages $1.2 trillion in fixed income assets. “Clearly the Fed is trying to get out of the business of quantitative easing,” he said, referring to asset purchases.

The statement provided no new language on the conditions for maintaining the pace of bond buying and repeated the pledge that policy makers have made since September to continue purchases until the jobs outlook has improved substantially.

Reversed Gains

The Standard & Poor’s 500 Index today reversed gains in New York, declining less than 0.1 percent to 1,685.73 after rising as much as 0.7 percent. Treasuries rallied after initial losses, with the yield on the 10-year Treasury note falling to 2.59 percent from 2.61 percent yesterday.

“A September tapering announcement still seems likely,” said Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. The FOMC is next scheduled to meet Sept. 17-18 in Washington.

“The bottom line for the Fed is the downside risks for the economy are diminishing,” he said. “If price gains decelerate to the point they worry about deflation, that might give them some pause” on tapering.

Price increases have stayed below the central bank’s 2 percent target for more than a year. The Fed’s preferred inflation gauge, the personal consumption expenditures index including, increased 1 percent through May. Excluding food and energy the index rose 1.1 percent.

Economic Risk

Bernanke told lawmakers July 17 that low inflation poses a risk to the economy, and policy makers “will act as needed” to ensure it rises toward their goal.

St. Louis Fed President James Bullard dissented from the previous Fed statement, saying the committee should “signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings.” He didn’t dissent today.

“Don’t forget Bernanke ran through programs before with two or three dissents,” said Eric Green, a former New York Fed economist who is now global head of rates, foreign exchange, and commodities research at TD Securities Inc. in New York. “They would only put that in, not just because of Bullard, but because other people share that opinion as well, even if they’re not as vociferous as Bullard.”

Kansas City Fed President Esther George dissented for the fifth meeting in a row, continuing to cite concern record accommodation may create financial and economic imbalances and increase long-term inflation expectations.

Remain Divided

The central bank said its bond purchases will remain divided between $45 billion a month of Treasury securities and $40 billion a month of mortgage-backed securities. The Fed also will continue reinvesting securities as they mature.

Bernanke, 59, said on June 19 that the FOMC may start scaling down bond buying later this year and halt it around the middle of 2014 as long as the economy performs in line with the committee’s expectations.

In semi-annual testimony to Congress on July 17, Bernanke said the labor market is “improving gradually” and that asset purchases “could be reduced somewhat more quickly” if the economy improved faster than expected. At the same time, he said the current pace of purchases “could be maintained for longer” if the employment outlook worsens.

None of the 54 economists in a July 18-22 Bloomberg News survey said they expected the central bank to alter the pace of purchases today. Fifty percent forecast that the Fed will first reduce bond buying at its Sept. 17-18 gathering.

Payrolls Rose

Payrolls have risen an average of 201,830 per month over the past six months. U.S. employers added 195,000 workers in June for a second straight month, the Labor Department said July 5, capping 12 months of advances above 100,000 for the longest such streak since May 2000.

At the same time, the jobless rate remains well above the Fed’s long-term unemployment forecast of 5.2 percent to 6 percent.

Economists and central bankers will know more about the jobs market on Aug. 2. The Labor Department’s monthly report may show that employers added 185,000 workers to payrolls in July and the jobless rate fell to 7.5 percent, according to a separate Bloomberg survey.

The Fed said today the economy “expanded at a modest pace during the first half of the year.” In the previous statement, it described the expansion as “moderate.”

Largest Economy

Policy makers concluded their meeting after a Commerce Department report today showed the world’s largest economy expanded at a 1.7 percent annual rate in the second quarter, more than economists forecast, as companies accumulated inventories at a faster pace. Growth in the first quarter was revised down to a 1.1 percent rate.

The gain in second-quarter gross domestic product showed the economy is overcoming the drag created by an increase in the payroll tax that took effect in January as well as across-the-board federal budget cuts known as sequestration, which began in March.

Growth will quicken as the impact from budget cuts wanes, Bernanke said in his congressional testimony. FOMC participants growth of 2.3 percent to 2.6 percent this year. Given today’s GDP report, the economy would have to expand 3.2 percent in the second half to meet the lower end of Fed forecasts.

The committee also acknowledged a recent rise in interest rates, saying that the housing market has been “strengthening, but mortgage rates have risen somewhat, and fiscal policy is restraining economic growth.”

Taper Buying

Borrowing costs have risen on speculation that an improving economy will prompt the Fed to taper bond buying.

The yield on the 10-year Treasury note soared to an almost two-year high of 2.75 percent on July 8 from 2.19 percent on June 18, the day before Bernanke said the Fed may consider reducing bond purchases this year if the economy performs in line with the central bank’s forecast. The yield rose yesterday 0.01 percentage point to 2.61 percent.

Speculation Fed purchases may slow has also lifted mortgage rates. The interest rate on a 30-year fixed home loan climbed to 4.31 percent last week, according to data compiled by Freddie Mac. The rate jumped a record 35 percent in 10 weeks ended July 11 to a two-year high of 4.51 percent, the data show.

U.S. stocks have rallied amid better-than-estimated corporate earnings. The Standard & Poor’s 500 Index advanced 18 percent this year through yesterday.

Target Rate

Bernanke lowered the Fed’s target interest rate near zero in December 2008 and has since embarked on three rounds of asset purchases to spur a recovery from the deepest recession since the Great Depression and keep the economy expanding.

The third round of quantitative easing may mark Bernanke’s final stimulus campaign. His term as Fed chairman ends in January, and President Barack Obama said in an interview last month that Bernanke has been at the Fed “longer than he wanted.” Larry Summers, former director of Obama’s National Economic Council, and Fed Vice Chairman Janet Yellen are candidates to succeed him.