Fed says U.S. economy weaker but leaves policy on hold

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The Federal Reserve stopped short of offering new monetary stimulus on Wednesday even as it signaled further bond buying could be in store to help a U.S. economic recovery that it said had lost momentum in 2012.

Fed officials described the economy as having 'decelerated somewhat,' a change of tone from its previous assessment in June when it said the economy had been 'expanding moderately'.

The Fed's policymakers also reiterated their disappointment with the slow pace of progress in bringing down the nation's 8.2 per cent jobless rate.

The central bank dashed expectations among some investors by taking no new measures, sending U.S. stocks lower and the dollar higher against the euro and the yen.

"They clearly underscored the downside risks to the economy and made it very clear they would be as accommodative as needed," said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey.

Many economists thought the central bank might extend further into the future its guidance for low rates but the statement maintained its late-2014 language.

The Fed nevertheless showed it was prepared to do more to support an ailing economy.

"The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed," the Fed said in its statement.

That was a slight shift from its June statement when the Fed said it was 'prepared to take further action as appropriate'.

Richmond Fed President Jeffrey Lacker again dissented against the late-2014 timetable.

U.S. economic growth slowed to 1.5 per cent in the second quarter as consumer spending faltered, and unemployment remains far too high for the comfort of a central bank that has a dual mandate to keep inflation low and employment high.

Job growth slowed sharply in the second quarter to just 75,000 jobs per month from 226,000 in the first quarter.

A report on Wednesday showed U.S. companies added 163,000 jobs in July, more than expected.

However, that survey, the ADP National Employment Report, does not carry as much weight as the government's more comprehensive labor market report due on Friday. It includes both public and private sector employment.

Manufacturing data from the Institute for Supply Management pointed to a second month of contraction in the factory sector.

EUROPEAN 'FIREWORKS'?

The Fed met a day before a key meeting of the European Central Bank. ECB president Mario Draghi last week ratcheted up speculation of further ECB purchases of Italian and Spanish bonds by saying he would do 'whatever it takes' to save the euro.

"The big fireworks will be tomorrow," said Jim Russell, chief equity strategist at U.S. Bank Wealth Management in Cincinnati.

"Anything short of (aggressive ECB action) will represent a disappointment to capital markets."

Europe's crisis is blamed for part of the U.S. slowdown, as fears of another financial crisis keep businesses and consumers on the defensive.

Against that grim backdrop, many think Fed chairman Ben Bernanke could use his speech at the central bank's high-profile gathering in Jackson Hole, Wyoming, in late August to send a strong message to markets.

He used that forum in 2010 to communicate the Fed's intention to pursue a second round of quantitative easing, or QE2.

A third installment of QE would probably involve some component of housing debt as the Fed attempts to breathe fresh life into a housing sector that is finally showing some signs of healing.

Other tools Bernanke has signaled are under consideration include lowering the interest the Fed pays banks to park their reserves at the central bank, currently at 0.25 per cent, which could induce them to boost lending.

Another option would be to pursue a 'funding for lending' program like the one recently implemented by the Bank of England, whereby the Fed might provide cheap short-term loans to banks in exchange for guarantees that banks will resume lending to individuals and firms.

The latter still requires some study, Bernanke said at his last press conference in June.