Fed's Rosengren plays down asset bubble risk, says QE3 working

MANCHESTER, New Hampshire (Reuters) - There is "little evidence" Federal Reserve bond purchases have caused financial instability and since the measures are working, they ought be continued for the rest of 2013, a senior central banker said on Wednesday.

Boston Federal Reserve President Eric Rosengren, a leading Fed dove who is a voting member of its policy-setting committee this year, said asset purchases had clearly helped ease U.S. unemployment, as he strongly played down talk of asset bubbles.

"Put simply, the benefits of our asset purchases have exceeded any reasonable estimate of the costs," Rosengren told bankers and business leaders in prepared remarks. "I see little evidence that our monetary policies are generating significant financial stability problems at this time."

The Fed last week voted to maintain asset purchases at a $85 billion monthly pace until it saw a substantial improvement in the outlook for the labor market, while pledging to hold interest rates near zero until the jobless rate hit 6.5 percent, provided inflation remained under 2.5 percent.

Rosengren acknowledged recent data showed that the U.S. economy was doing "a bit better than expected", but argued that it still remained far from where the Fed wanted it to be as he reiterated a call to keep buying bonds for the rest of 2013.

U.S. unemployment was 7.7 percent in February.

Wall Street stocks have notched record highs as investors bet the economic recovery was on track, while house prices have also advanced as the battered real estate market turned around, and rates on high-yield bonds have hit historic lows.

Rosengren discussed each market and spelled out why he saw good reasons to explain current valuations.

Stocks reflected higher operating earnings and the earnings to index ratio was still below its 20-year average, he said. House prices were well under their peak, while a ratio of house prices to rents was back at its level of 1993. High yield bond rates, while low, had not declined more than other market rates.

"In sum, broad-based financial stability concerns do not seem particularly acute at this time," he said. "Interest rates in most markets have fallen, and asset prices are rising. This is the expected and intentional result of the Fed's efforts to promote a more rapid return to more normalized conditions."

However, Rosengren did have words of warning for sectors where underwriting standards might have slipped, and he noted that investor protection covenants on some newly issued high-yield bonds may have been diluted.

He also said investments based on short-term borrowing to finance long-term assets should be kept under close watch, singling out agency real estate investment trusts (REITS), which have recently drawn attention from other senior Fed officials.

"While the benefits of our actions continue to outweigh the costs, we need to closely monitor financial instruments, financial institutions, and financial markets for potentially emerging financial stability concerns," he concluded.

(Writing by Alister Bull; Editing by Chizu Nomiyama)