By Pedro da Costa and Alister Bull
WASHINGTON (Reuters) – The Federal Reserve ramped up its stimulus to the economy on Wednesday, expressing disappointment with the pace of recovery in employment as contentious U.S. budget talks heighten uncertainty about the outlook.
The central bank replaced a more modest stimulus program due to expire at year-end with a fresh round of Treasury purchases that will increase its balance sheet. It committed to monthly purchases of $45 billion in Treasuries on top of the $40 billion per month in mortgage-backed bonds it started buying in September.
In a surprise move, the Fed also adopted numerical thresholds for policy, a step that had not been expected until early next year. In particular, the Fed said it will likely keep official rates near zero for as long as unemployment remains above 6.5 percent, inflation between one and two years ahead is projected to be no more than 2.5 percent, and long-term inflation expectations remain contained.
The Fed noted unemployment remains elevated and that inflation is running somewhat below policymakers’ 2 percent objective.
“The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions,” the Fed said in a statement.
Policymakers also repeated a pledge to keep buying bonds until the labor market outlook improves substantially. A drop in the jobless rate to 7.7 percent in November from 7.9 percent in October was driven by workers exiting the labor force, and therefore did not come close to satisfying that condition.
Under the “Operation Twist” program that will expire at the end of the month, the Fed was buying $45 billion in longer-term Treasuries with proceeds from the sale of short-term debt. The new round of government bond-buying it announced on Wednesday will be funded by essentially creating new money, further expanding the Fed’s $2.8 trillion balance sheet.
Fed Chairman Ben Bernanke will discuss the central bank’s latest decision at a news conference at 2:15 p.m. (1915 GMT).
SWEATING A WEAK RECOVERY
The Fed cut overnight interest rates to near zero in December 2008 and has bought about $2.4 trillion in bonds in a further effort to push borrowing costs lower and spur a stronger recovery.
Despite the unconventional and aggressive efforts, U.S. economic growth remains tepid. GDP grew at a 2.7 percent annual rate in the third quarter, but it now appears to be slowing sharply. According to a Reuters poll published on Wednesday, economists expect the economy to expand at just a 1.2 percent pace in the current quarter.
Businesses have hunkered down, fearful of a tightening of fiscal policy as politicians in Washington wrangle over ways to avoid a $600 billion mix of spending reductions and expiring tax cuts set to take hold at the start of 2013.
Bernanke has warned that running over this “fiscal cliff” would lead the economy into a new recession.
Fed officials will release a new set of quarterly economic and interest rate projections at 2 p.m. (1900 GMT) that could show yet another round of downward revisions to future growth prospects.
Back in September, the Fed predicted the U.S. economy would expand 2.5 percent to 3 percent in 2013, but even that modest rate is looking potentially rosy. The Reuters poll showed a median U.S. growth estimate of 2.1 percent for next year on the same fourth quarter over fourth quarter basis. (Writing by Pedro Nicolaci da Costa; Editing by Andrea Ricci)