Fed set to downgrade its outlook on US prospects

THE FEDERAL Reserve is set to downgrade its assessment of US economic prospects when it meets tomorrow to discuss ways to reboot the flagging recovery.

Faced with weak economic data and rising fears of a double-dip recession, the Federal Open Market Committee (FOMC) is likely to ensure its policy is not constraining growth and to use its statement to signal greater concern about the economy. It is, however, unlikely to agree big new steps to boost growth.

Smaller measures to help the economy could initially take the form of a decision to reinvest proceeds from maturing mortgage-backed securities held by the US central bank, thereby preventing the Fed’s balance sheet from shrinking naturally.

Investors will also examine closely any changes to the pledge made by the FOMC in June to “employ its policy tools as necessary to promote economic recovery and price stability”, which could be hardened if policymakers choose to signal the potential for a more aggressive move to boost the economy in the future.

Even if that happens, though, most economists believe it would take several more months of poor data for the Fed to actually begin a new round of asset purchases on the scale of those carried out during the recession.

Although Fed policymakers still believe the basic trajectory of the economy remains one of moderate expansion, there may be more attention given to heightened dangers of a sharp slowdown.

“The FOMC will have to tone down its assessment of the economy in view of recent weak indicators on real growth, real consumption spending and employment,” said Brian Bethune and Nigel Gault, economists at Global Insight.

The latest poor reading came in Friday’s monthly employment report, which showed the US private sector creating only 71,000 jobs in July – not enough to keep up with population growth, let alone bring down the unemployment rate.

That followed news a week earlier that growth in US gross domestic product (GDP) slowed from an annualised rate of 3.7 per cent in the first quarter to 2.4 per cent in the second quarter.

The US economy would improve slowly and another round of fiscal stimulus would likely not be effective, former treasury secretaries Paul O’Neill and Robert Rubin said in an interview on television network CNN yesterday.

Mr Rubin, who served under Democratic president Bill Clinton, said the US was “going to have slow and bumpy growth”. A “major second stimulus” might create uncertainty and undermine confidence, he added.

Mr O’Neill, who was treasury secretary under Republican president George W Bush, said companies were concerned about demand and would not expand facilities and hire new employees until sales had improved.

“I think we are moving forward at a pretty gradual pace,” he added, “but I don’t think things are terrible.” – (Copyright The Financial Times Limited 2010; Additional reporting Bloomberg)