Fed set to apply new stimulus, question is how

Having tipped its hand, the Federal Reserve is likely to announce this week it will resume large-scale asset purchases to boost an economic recovery too weak to bring down high unemployment.

Since Fed chairman Ben Bernanke first suggested the possibility in late September, and confirmed it in October, markets and most economists have penciled in another round of quantitative easing (QE) as a solid bet.

With the long drum roll heightening expectations, the central bank's policy-setting Federal Open Market Committee is expected to announce the second round of bond purchases, dubbed QE2, after a meeting Wednesday.

"The November FOMC meeting has arguably been the most highly expected this year," Nomura Global Economics analysts said in a client note.

It opens Tuesday in the thick of hotly contested congressional and local elections nationwide.

President Barack Obama's Democrats are poised to lose seats in Congress to Republicans, who oppose the administration's massive stimulus spending that dragged the economy out of the worst recession since the Great Depression, but ran up sky-high deficits doing it.

The Fed's coincidental intersection with the mid-term elections, however, should not sway the independent bank, whose current dual-mandate is price stability and maximum employment.

A government report Friday showing only modest third-quarter economic growth bolstered expectations of further Fed stimulus to lower long-term interest rates and fight off deflationary pressure in the slack economy.

The world's largest economy grew at a 2.0 percent annual rate in July-September, in line with expectations, slightly more than a 1.7 percent expansion in the second quarter.

Economists consider that economic growth must reach about three percent for some time to significantly reduce high unemployment.

But more than a year after the recession officially ended, unemployment has been hovering near double-digits.

When the government reports nonfarm payrolls on Friday, the jobless rate was expected to remain stuck at 9.6 percent for the third straight month in October.

"The US economic recovery continues on, but growth remains too weak to cause a serious improvement in the labor market," said Augustine Faucher at Moody's Analytics.

"The central bank will not increase the fed funds rate for more than a year, until after the unemployment rate moves decisively lower," he added.

The FOMC has held its key interest rate at virtually zero since December 2008 to boost growth, and has indicated there will be no change any time soon.

Uppermost in minds was how much the Fed will pump into the financial system, effectively printing money in an effort to lower long-term interest rates, and whether the injection will heal the ailing economy or make it worse.

The Fed already has poured in more than 1.5 trillion dollars to spark a recovery.

IHS Global Insight analysts Nigel Gault and Brian Bethune said estimates of the size of the expected program have ranged from 500 billion to over a trillion.

"Our best guess is that the FOMC will launch a program of at least 500 billion dollars, and possibly with some flex of up to 800 billion," they said in a note to clients.

A number of analysts said the Fed probably would launch a set of incremental purchases and adjust the program based on the economy's performance.

The Nomura analysts predicted the FOMC statement would include a commitment to continue buying until the committee’s forecasts show significant progress toward full employment and 2.0 percent inflation.

Moody's Faucher said that risks were weighted to the downside, and the probability of a double-dip recession was close to one in three.

"The most serious problem right now is a lack of confidence," he said.

"If consumers are worried about job growth and hold back on spending, or if business cut back on investment and hiring because of a lack of credit or concerns about the permanence of the recovery, the economy could fall back into recession."

Source AFP