Fed declares recovery for 1st time, lays ground for stimulus exit

Written by Bloomberg | Updated: Jan 29 2010, 06:01am hrs
The Federal Reserve panel in charge of interest rates declared for the first time the US economy is in recovery and took several steps to prepare investors for the removal of aggressive monetary stimulus.

The Federal Open Market Committee (FOMC) on Wednesday upgraded its economic outlook, reaffirmed it will end liquidity backstops and a $1.25-trillion program to buy mortgage-backed securities and expressed less confidence inflation will remain subdued.

This is as close an admission that we are likely to see that the FOMC thinks the recession is over and the economy is on a self-sustaining recovery path, said Christopher Rupkey, chief financial economist at the Bank of Tokyo-Mitsubishi UFJ Ltd in New York. Policy makers need to think seriously on how they are going to reset the message on the low rates policy.

Central bankers repeated their pledge to keep the benchmark lending rate in a range of 0- 0.25% for an extended period, while noting the economy continued to strengthen. Kansas City Federal Reserve Bank president Thomas Hoenig dissented, favoring a quicker adjustment to the rate outlook message. Hoenig believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted, the FOMC said in Wednesdays statement.

Inflation is likely to be subdued for some time, policy makers said. Last month, the panel said inflation will remain subdued. They are starting to get more comfortable with the sustainability of the recovery, said Stephen Stanley, chief economist at RBS Securities Inc. in Stamford, Connecticut. The downside risks that they were so worried about are probably still there but diminishing in importance. Policy makers are winding down the record amounts of credit they have provided since the bankruptcy of Lehman Brothers Holdings Inc in 2008.

The Fed also repeated that it will close four programmes supporting money markets and bond dealers in February, as well as dollar swap programmes with central banks in Europe and Asia.

The central bank is prepared to modify these plans if necessary to support financial stability and economic growth, the statement said. The Fed also said it is winding down the Term Auction Facility and will hold a final auction on March 8.

Chairman Ben S Bernanke is looking for signs that the return to economic growth is accompanied by the prospect of stronger hiring and an increase in credit to people and businesses. The Senate plans to vote on limiting debate and preventing lawmakers from blocking a vote on Bernankes nomination. As of Wednesday, 50 senators said they would vote for or were inclined to support Bernanke, while 22 were opposed, according to a tally by Bloomberg News.

The US unemployment rate held at 10% in December, while consumer credit dropped a record $17.5 billion in November.

Household spending is expanding at a moderate rate, but remains constrained by a weak labour market, modest income growth, lower housing wealth, and tight credit, the Fed said in its statement. Employers remain reluctant to add to payrolls, and bank lending continues to contract, the FOMC said.