The Federal Reserve concludes its two-day policy meeting on Wednesday with a big question looming; will it take some new action to jolt the U.S. economy out of its slump?
Investors are hoping the Fed will announce another round of bond purchases, known as quantitative easing. The goal is to lower long-term interest rates and encourage more borrowing and spending.
But economists say the Fed is likely to hold off until September to wait and see if job growth and consumer spending picks up.
U.S. growth slowed to an annual rate of 1.5 percent from April through June, down from the 2 percent pace in the first quarter. And consumers spent no more in June than they did in May, even though their income grew by 0.5 percent.
Fed officials have signalled their concern about weakening job growth and consumer spending, which have brought the economy closer to a standstill. Federal Reserve Chairman, Ben Bernanke, has said the Fed is prepared to take further action if unemployment stays high.
“The weakness of the economy will force them to act,” said David Jones, chief economist at DMJ Advisors. “Bernanke has been really straightforward. He has said if the recovery loses momentum and labour market conditions are not improving, we will get more easing.”
One possibility is that the fed could extend a plan to keep its benchmark interest rate near zero, from late-2014 until to mid-2015. The goal of such a move would be to assure consumers and businesses that they will be able to borrow cheaply well into the future. But it also signals that the Fed expects the economy to stay weak for some time.
The European Central Bank meets on Thursday, and the U.S. Labour Department releases the July jobs report on Friday.
Economists forecast that U.S. employers will add 100,000 jobs in July. That would be only slightly better than the 75,000 a month from April through June and still down from a healthy 226,000 average in the first three months of the year. The unemployment rate is expected to stay at 8.2 percent.
Worries have also intensified about Europe’s debt crisis and whether the U.S. economy will fall off a “fiscal cliff” at the end of the year. That’s when tax increases and deep spending cuts will take effect unless Congress reaches a budget deal. A recession could follow, Bernanke has warned.
The Fed has already pursued two rounds of purchases of Treasury bonds and mortgage-backed securities.
The Fed has also extended a program called Operation Twist. Under this program, the Fed sells short-term Treasurys and buys longer-term Treasurys. The goal is to lower longer-term interest rates.
Even if the Fed launched a third round of bond purchases, few think that further lowering long-term rates would provide much benefit to the U.S. economy. Most businesses and consumers who aren’t borrowing now aren’t likely to change their minds if rates slipped a bit more.
Some regional Fed bank presidents have expressed concern that expanding the Fed’s investment portfolio beyond its current record $2.9 trillion to try to lower rates even further, would heighten the risk of high inflation later.
“Various Fed officials have made it pretty clear they want to do something, but they still have a lot of discussion to go through before they get to a decision,” said Diane Swonk, chief economist at Mesirow Financial in Chicago. “How do you get the biggest bang for the dollar when the ammunition you have left is limited?” she added.
Some analysts have also suggested that the Fed might be reluctant to act aggressively as the November election nears, out of concern it could be seen as affecting the vote.
Though at record lows, mortgage rates are still higher than rates on some other loans. Further declines in those rates could help fuel home sales.
