Federal Reserve could cut interest it pays on banks’ reserves

The US Federal Reserve could cut the interest it pays to banks on their reserves in a dramatic move to offset an eventual slowing of its $85 billion-a-month asset purchases.

The central bank offered no hints on when it could “taper” its quantitative easing, reiterating that it might make the move “in coming months”. But the rate-setting Federal Open Market Committee’s discussion of alternatives suggests it is keen to slow its buying.

Cutting the extra interest on reserves that banks hold with the Fed would drive down already-low overnight interest rates further, probably to a few basis points, hurting bank profits but adding extra stimulus to the economy.

According to the minutes of its October meeting, most FOMC officials thought such a move “could be worth considering at some stage” as a way to signal continued easy monetary policy after they start to slow asset purchases.

The Fed had an extensive discussion of policy plans at the meeting, indicating it is keen to taper the asset purchases that have driven global financial markets for the last year, but also that it wants to offset reduced purchases with a new form of easing.

The option that won the most obvious support was a cut in the 25 basis points of interest that the Fed pays to banks on the $2.5 trillion in reserves they have accumulated as a result of its asset buying programme.

Another possibility was to add language to the Fed’s statement to describe what would trigger a rise in interest rates. It could also say that rates are likely to rise only slowly when they do eventually take off.

Federal Reserve chairman Ben Bernanke used such language in a speech on Tuesday. He said rates were likely to stay low "for a considerable time after the asset purchases end".

The minutes show Federal Reserve officials still expect to “trim” their asset buying in the coming months as a result of improvement in the labour market.

But they also considered scenarios where they would lower purchases before “an unambiguous further improvement in the outlook was apparent”.

– (Copyright The Financial Times Limited 2013)