Fed officials keep door open on easing, eye risks

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Several Federal Reserve policymakers last month thought the U.S. central bank might need to do more to support the economy if the recovery stumbles, but there was almost no support for extending its 'Operation Twist' program, due to end in June.

Minutes of the Fed's most recent policy-setting meeting, released on Wednesday, suggested officials were inclined to stay their current course, given a 'moderately' expanding economy and improved labour market conditions.

But while half saw risks to the outlook as broadly balanced, nearly all the rest saw dark clouds on the horizon, both at home and abroad.

"Participants identified several downside risks to the projected pace of economic expansion, including the fiscal and financial strains in the euro area and the possibility of an abrupt fiscal consolidation in the United States," the minutes said.

Some policymakers, including Fed chairman Ben Bernanke, have expressed concern over the severe hit the economy would take if politicians do not take steps to postpone some of a raft of spending cuts and tax hikes -- dubbed the 'fiscal cliff' - due to take place in January as planned.

Even if the fiscal cliff is averted, policymakers worried that uncertainty over the budgetary path could hold back household and business spending, the minutes suggested.

Those worries may be behind what appeared to be increased support at the April meeting for a third round of quantitative easing, should the recovery sour.

Several members of the Fed's policy-setting committee "indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough," according to the April meeting minutes.

In March, the minutes said a 'couple' of members thought more stimulus might be needed. The risks may have increased since the late April meeting.

Government data in early May showed unemployment fell last month, to 8.1 percent, but only because more people had given up looking for work.

More recently, a political crisis in Greece has sparked worries the debt-laden country could leave the European Union's common currency zone.

"All things considered, the chances of a QE3 are probably a little higher than we previously thought," Paul Ashworth, chief U.S. economist for Capital Economics, wrote in a note.

"But, on balance, we still don't anticipate any Fed action unless the fallout from Greece's exit from the single currency turns out to be more disruptive than we suspect it will."

Economists in recent days have pegged the chance of a third round of quantitative easing at about 30 percent, according to a Reuters poll.

The Fed has kept short-term interest rates near zero since December 2008 and has bought $2.3 trillion in long-term securities to shore up a sometimes faltering recovery.

After their April 24-25 meeting, Fed officials said the weak economy would likely warrant keeping rates exceptionally low through late 2014.

Fed chairman Ben Bernanke at the time said U.S. monetary policy was 'more or less in the right place' but the central bank would not hesitate to open the monetary spigots further 'should the economy require that additional support'.

In the minutes, published Wednesday, some members said they would favor changing the Fed's current stance 'only once they were more confident that the medium-term outlook or risks to the outlook had changed significantly'.

The president of the St. Louis Fed, James Bullard, who is considered a policy centrist, on Wednesday echoed that view, saying he expects the Fed to keep policy on hold until there is a clear change in economic outlook.

He also warned that the main risk to policy is that the central bank over-commits to a super-loose course of action.

Only one participant in the April policy-setting meeting thought the Fed should extend its current bond-buying program, known as Operation Twist, that is due to be completed next month.

That program is designed to push down long-term borrowing costs by adding to the Fed's long-term securities holdings, while selling a like amount of its shorter-term holdings.

HAWKS TALK

Several Fed officials since the April meeting have said they see no need now for more easing.

Some, including policy hawks like Philadelphia Fed President Charles Plosser and Minneapolis Fed President Narayana Kocherlakota, have called for the U.S. central bank to start removing accommodation as soon as this year.

Still, new data included with the minutes suggested there was still ample support for the current late-2014 guidance.

About half of participants in the April meeting said that exceptionally low rates would be appropriate at least until late 2014.

The moderately dovish tone of the minutes led traders to push out to July 2014 their expectations for a first Fed rate hike, based on short-term interest-rate futures listed at the Chicago Board of Trade. Before the minutes they saw June 2014 as the timing for the likely first rate hike.