Fed moves to support economy

The US Federal Reserve today said it would begin funneling proceeds from its maturing mortgage bonds into longer-term government…

The US Federal Reserve today said it would begin funneling proceeds from its maturing mortgage bonds into longer-term government debt in an effort to support a sputtering economic recovery.

The Fed, which left benchmark overnight interest rates steady in a zero to 0.25 per cent range, also renewed its pledge to keep them low for an extended period, as widely expected.

The decision to reinvest mortgage bond proceeds, an effort to keep market-set borrowing costs down, represents a significant policy shift for a central bank that just a few months ago had been avidly debating an exit strategy from the extraordinary stimulus delivered during the financial crisis.

"To help support the economic recovery in a context of price stability, the committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities," the Fed said in a statement.

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The move was somewhat surprising. Although many analysts and investors had expected the Fed to announce it was reinvesting the mortgage proceeds, most had thought it would buy more mortgage debt instead of government bonds.

In a statement at the close of a one-day meeting, Fed officials offered a more gloomy outlook for the economy, saying the recovery in output and employment "has slowed in recent months." When it last met in late June, it said the recovery was "proceeding".

Data has been decidedly weak since the US central bank's last meeting in late June. Consumer spending has softened and manufacturing appears to be losing steam. The unemployment rate, meanwhile, is stuck at 9.5 per cent.

With US interest rates already effectively at zero, the central bank has run out of easy policy options. Top Fed officials argue, however, they can do more to fight renewed economic weakness, including reinvesting proceeds from maturing mortgage bonds back into that market.

Other Fed options include lowering the rate it pays banks to park their excess reserves at the central bank, currently at an already low 0.25 per cent, or somehow redoubling its already-stated commitment to keep interest rates low.

The idea is to prevent a deflationary cycle of falling prices and depressed consumption from taking hold. Consumer prices outside food and energy rose just 0.9 percent in the 12 months through June, holding for a third straight month at the lowest level seen since January 1966.

Reuters