Fed officials warn of looming problems for economy

The Federal Reserve is open to taking further action to support the struggling U.S. economy. But minutes of the Fed’s June meeting show policymakers at odds over whether the economy needs more help now.

Fed officials signaled their concern that the struggling U.S. economy could worsen if Congress fails to avert tax hikes and across-the-board spending cuts that kick in at the end of the year. And they expressed worries that Europe’s debt crisis will weigh on U.S. growth.

Some members noted that defense contractors are already laying plans for layoffs if lawmakers don’t address the package of tax hikes and spending cuts by the end of the year. Members warned that tighter government spending could slow the economy well into next year.
The Fed downgraded its economic outlook. It now expects growth of just 1.9% to 2.4% in 2012, half a percentage point lower than its April forecast.

A few members said the economy may already require additional support. But several others noted that further action “could be warranted” if the recovery lost momentum, if risks became more pronounced or inflation seemed likely to run below the committee’s target.

Investors appeared disappointed by the division within the Fed.

Stock prices sank after the Fed expressed concern about the economy. The Dow Jones industrial average had been down nearly 40 points before the minutes were released at 2 p.m. ET. Around 2:30 p.m., the Dow was down 112 points, on track for its fifth straight day of losses.

Since the Fed met June 19-20, the job market’s weakness has persisted. The government said Friday that hiring in June was weak for a third straight month. The economy added just 80,000 jobs.

David Jones, chief economist at DMJ Advisors, said he didn’t think Fed officials would have announced any new action at its June meeting even if they’d known how weak the June employment report would be.

Jones said he thinks the Fed will launch a new bond buying program eventually. But he says the timing remains hazy.

“These minutes show that there is still a very deep division within the Fed,” Jones said.

Many economists predict the Fed won’t announce any new steps at its next meeting July 31-Aug. 1. They think officials will hold off for one more meeting and give the job market a little longer to show improvement. If the economy doesn’t improve, the Fed could announce some new action at its Sept. 12-13 meeting.

Since the recession, the Fed has bought more than $2 trillion in Treasury bonds and mortgage-backed securities, expanding its portfolio to more than $2.8 trillion.

In the meantime, Jones said the Fed might decide at its next meeting to extend its timetable for when it plans to increase short-term interest rates. The Fed now plans to keep a key short-term rate at a record low until at least late 2014. Jones said officials might push that target into 2015 to reassure investors that borrowing costs will stay low even longer than expected.

More stimulus “won’t become a reality unless the recovery loses even more momentum or a more severe flare up in the euro-zone crisis raises the already elevated downside risks,” said Paul Ashworth, chief U.S. economist at Capital Economics.

Members said the economy will likely continue to grow moderately. But the Fed lowered its growth forecast at the June meeting, noting that the U.S. job market had weakened and consumer spending slowed. It also said it didn’t expect the unemployment rate to fall much further this year from its current 8.2%.

At the meeting, the Fed extended a program that shifts its bond portfolio to try to lower long-term interest rates. Policymakers left open the possibility of providing further help, such as launching a new program of bond purchases.

Chairman Ben Bernanke may offer further guidance on the Fed’s plans next week when he delivers the central bank’s updated economic assessment to Congress. After the June meeting, Bernanke told reporters he was open to another round of bond purchases if the job market didn’t improve.

Employers added an average of just 75,000 jobs a month in the April-June quarter — only about a third of the 225,000 jobs a month created in the first three months of the year.

USA Today