Fed Likely to Signal Economy Improving, Keep Interest Rates Low

By Vivien Lou Chen and Scott Lanman

Nov. 4 (Bloomberg) -- Federal Reserve officials may today indicate their $1 trillion injection into the economy is helping to revive growth without requiring an increase in interest rates from near zero, economists said.

Policy makers will probably maintain their commitment to keeping rates low for an “extended period,” said Laurence Meyer, vice chairman of Macroeconomic Advisers LLC in Washington and a former Fed governor. They may also start a discussion about altering the wording of their policy statement, to leave them more leeway to signal a change in the future.

Chairman Ben S. Bernanke and his colleagues are reluctant to raise rates until the labor market shows signs of recovery, even though a report last week showed the economy resumed growth after 12 months of contraction. The Fed isn’t yet willing to signal that it’s ready to join central banks in Australia, Norway and Israel in pushing borrowing costs higher.

“They’ve got, for a lot of reasons, to say that it looks like what we’ve been doing has been working,” said former Atlanta Fed research director Robert Eisenbeis, now chief monetary economist at Cumberland Advisors Inc. in Vineland, New Jersey. “But if they’re too exuberant about it, it’s going to trigger expectations of a policy move quicker than perhaps they might like to do.”

Members of the Federal Open Market Committee, whose two-day meeting ends today, may be concerned any hint of a change in policy would prompt investors to sell Treasury bonds, sending rates higher on consumer and business loans and endangering the recovery, analysts said. A statement is due around 2:15 p.m.

Worst Recession

The Fed, while trying to pull the economy from its worst recession since the Great Depression, has held the benchmark lending rate close to zero since December while using asset purchases as its main policy tool. The unprecedented monetary stimulus helped fuel 3.5 percent growth during the third quarter.

Much of the expansion stemmed from government incentives for the purchase of cars and homes that boosted consumer spending, which accounts for about 70 percent of the economy. Excluding sales, production and inventories of automobiles, the economy grew 1.9 percent last quarter.

Growth “looks really good on the face of it, but the key question is whether it is sustainable,” said Tom Porcelli, a senior economist at RBC Capital Markets in New York. “A large chunk of the gain was stimulus related. A lot of it was artificially generated.”

The economy will probably expand at a 2.4 percent annual rate from October through December, according to the median forecast in a survey of economists last month.

‘Uneven Recovery’

Bernanke and Fed Vice Chairman Donald Kohn “expect a very fragile and uneven recovery,” said former Fed economist David Milton Jones, president of Denver-based DMJ Advisors and author of four books on the central bank.

Policy makers will probably reiterate that slack in the economy and stable expectations for inflation will limit a broad increase in prices “for some time,” analysts said.

Inflation “will be low in the near term,” said Eisenbeis, adding that the doubling in the Fed’s assets since September 2008 to $2.16 trillion may spark higher prices in the longer term. “I see, with the buildup in the Federal Reserve’s balance sheet, a lot of threats there,” he said.

Investors are pouring money into inflation-linked debt to prepare for a surge in the cost of living spurred by the $11.6 trillion the Fed and government lent, spent or guaranteed to bolster the economy and financial system.

Inflation Expectations

The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 2.06 percentage points yesterday from 1.80 points on Sept. 23. The TIPS spread is a sign that long-term inflation expectations are rising, challenging Fed efforts to keep policy accommodative.

Record central bank liquidity has also stoked a rise in asset prices. The Standard & Poor’s 500 Index has rallied 55 percent from a 12-year low in March, while crude-oil futures are up 78 percent this year.

Investors, reacting to signs of a recovery, have created “bubbles in oil prices” and equities, Jones said. “Bubbles are a nightmare for the Fed.”

Still, with unemployment rising, policy makers will reiterate their intent to hold the federal funds rate at “exceptionally low levels,” analysts said. The jobless rate reached a 26-year high of 9.8 percent in September and economists project it will exceed 10 percent by early next year.

‘Very Accommodative’

“The Fed’s dual mandate includes full employment, and as long as the jobless rate is in its present vicinity, then monetary policy has to stay very accommodative,” said Richard DeKaser, chief economist at Woodley Park Research in Washington.

Since their previous meeting in September, central bankers have voiced differing views on the pace and timing of a change in monetary policy.

Fed Governor Kevin Warsh said Sept. 25 interest rates may need to rise “with greater force” than usual, while New York Fed President William Dudley said Oct. 5 the recovery’s pace “is not likely to be robust” and inflation risks are “on the downside.”

An increase in the main interest rate is “a long ways off,” Gramley said. The economy “needs continued sustenance.”

To contact the reporters on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.netScott Lanman in Washington at slanman@bloomberg.net.