ECONOMY|MARCH 15, 2011, 3:12 P.M. ET
Fed Leaves Policy Unchanged Amid Global Shocks
By LUCA DI LEO And JEFFREY SPARSHOTT
The Federal Reserve kept its easy-money policies intact as markets reeled from a series of global shocks that could upset a firming U.S. recovery, which Fed officials indicated was just starting to take hold.
Fed officials also said the strong rise in international commodity prices was putting upward pressure on prices. Officials said that, while they would monitor the evolution of inflation closely, they expect the effects of higher oil prices to be transitory.
After their policy-setting meeting Tuesday, central bank officials noted further improvements in consumer spending amid a slightly brighter U.S. jobs picture.
While they didn't mention Japan's earthquake and tsunamis directly, the devastating natural disaster has added to the list of potential risks to U.S. growth prospects. Since the FOMC's last meeting January 25-26, oil price rises have accelerated as investors fret that turmoil in North Africa and the Middle East could hit supply. Meantime, Europe's sovereign debt concerns continue to linger.
Fed officials no longer characterized progress toward their dual objectives of low inflation and low unemployment as "disappointingly slow", as they did in January. But given the cautious outlook, Fed officials voted unanimously to keep in place their government bond purchases and to maintain a pledge that short-term interest rates will stay close to zero for an "extended period".
U.S. stocks fell sharply on Tuesday, joining a global market selloff which began in Tokyo after Japan's nuclear crisis deepened. The selloff came following news of two more explosions at Japan's Fukushima Daiichi nuclear-power plant, releasing large amounts of nuclear material. Japanese Prime Minister Naoto Kan warned of "substantial" radiation leaks. Investors around the world are likely to remain nervous amid developments in Japan and unrest in oil-rich countries.
Since the Japan quake, financial markets have pared back their expectation for when the Fed could increase interest rates. The February 2012 Fed-Funds futures contract, measuring expectations for the FOMC meeting in late January of next year, is currently pricing in just a 20% chance the Fed could raise its rate to 0.5%. That's down from a 52% chance last Thursday, the day before the quake hit.
The Fed noted that consumer spending, a key growth-engine for the U.S. economy, was still expanding as U.S. labor market conditions "appear to be improving gradually." The unemployment rate fell to 8.9% in February from 9.4% in December, but growth is unlikely to be strong enough in the coming months to produce further strong declines in the number of jobless people.
Compared to January, the central bank tweaked its statement to reflect the recent small increase in certain price gauges. But despite the strong rise in oil and food prices -- and a recent increase in an indicator of where consumers see prices in the years ahead -- the Fed said underlying inflation was "subdued" and repeated that "longer-term inflation expectations have remained stable."
Unlike the European Central Bank, which has signaled it's likely to raise rates in April to avoid higher oil prices from igniting inflation, the Fed is also concerned that rising energy prices could hit economic growth by hurting consumer spending. In testimony to Congress at the start of the month, Fed Chairman Ben Bernanke put the same emphasis on both risks.
Economists at forecasters Macroeconomic Advisers expect higher oil prices, coupled with the prospect of quicker and deeper government spending cuts at home than previously anticipated, to shave half a percentage point from their 3.7% U.S. economic growth forecast this year. The political climate in Washington has recently become more favorable to the kind of bargaining needed to cut federal spending-and more cuts are expected at the state and local level.
The impact of the Japan quake is harder to determine. But what's already evident is that uncertainty about nuclear risks and how Japan's quake and tsunami will hit the world economy is having ripple effects throughout global financial markets. The cost of insuring government debt, for example, has risen sharply both in Japan and Europe as investors worry about high sovereign debt levels in both areas.
"The near-term impact on Japanese growth is likely to be negative and potentially quite large," Nariman Behravesh, chief economist at IHS Global Insight, wrote in a note. But he added the reconstruction effort should provide a boost to growth by the end of the year and the impact on the world economy should be small, given that Japan is no longer an engine for global growth.
The FOMC meeting wasn't attended by governor Kevin Warsh, who has announced he will step down at the end of the month, leaving the seven-member Fed board in Washington with two empty seats at a challenging time for the central bank.
Nobel-winning economist Peter Diamond made a new pitch to the Senate to join the Fed earlier this month, but he could struggle to get the job amid Republican opposition.
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Fed Leaves Policy Unchanged Amid Global Shocks
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