Fed Seen Dialing Down GDP Forecasts

Reuters

The Federal Reserve will likely nod to renewed weakness in the U.S. economy in a post-meeting policy statement on Wednesday, but don't expect policymakers to do anything about it any time soon.

That's in part because underlying inflation, considered too low in the period preceding the launch of the central bank's most recent round of bond purchases, has been rising.

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Moreover, the central bank faced intense criticism as its second round of so-called quantitative easing -- a $600 billion bond purchase program known as QE2 -- sparked accusations that policymakers were sowing the seeds for future inflation.

A Fed spokesman said the policymakers resumed a two-day meeting at 9 a.m. EDT.

The U.S. economic recovery, nearing its second anniversary, appears to be losing steam. Gross domestic product grew at just a 1.8 percent annual rate in the first quarter, and the second quarter's performance is not looking much better.

Fed Chairman Ben Bernanke, in his second-ever news conference after the meeting, will most probably reiterate his forecast for a rebound in the second half of the year.

"I would expect that the chairman would be pretty firm in his view that the recovery will proceed in the second half," said Michael Gapen, an economist for Barclays Capital.

Still, likely downward revisions to the central bank's growth forecasts for 2011, which at 3.1 percent to 3.3 percent as of April are now looking a bit lofty, will offer a public acknowledgment that the economy continues to disappoint.

Fed officials cut interest rates to near-zero in December 2008 and will have pumped $2.3 trillion into the economy by the time their bond purchases run their course at the end of this month in the hopes of spurring a stronger recovery.

TRANSITORY OR FUNDAMENTAL?

Bernanke is likely to face tough questions about Greece and the impact of Europe's debt woes on the United States, an issue that has roiled financial markets. But the Fed chief will try his best to duck any specifics, deferring instead to his European counterparts.

U.S. stocks opened lower on Wednesday on investor caution about how the Fed would handle the slowdown in momentum in the world's largest economy. U.S. Treasury prices rose and the dollar was little changed.

At the very least, the mix of turbulence abroad and renewed malaise at home should dampen any talk of withdrawing stimulus for now, and delay the eventual start date of any monetary tightening cycle.

In a statement due for release around 12:30 p.m. (1630 GMT), the Fed looks set to repeat its commitment to keeping interest rates low for an extended period, while also restating an intention to continue reinvesting proceeds from maturing bonds it holds back into the Treasury market. Bernanke's news conference will follow at 2:15 p.m. EDT.

The central bank and its chairman will have to describe the inflation outlook with some nuance, since energy costs have come down rapidly even as "core" inflation readings that exclude food and energy have edged higher.

The labor market picture should be of particular concern. In May, the economy added a paltry 54,000 net new jobs, while the jobless rate rose to 9.1 percent from 9.0 percent.

That is hardly the sort of trend economists might have expected to see two years into a recovery, and it has marked a reversal of fortunes after several strong months, reinforcing fears of a fundamental loss of economic momentum.

Housing also remains a sore spot. The sector has not only failed to recover, it has been slumping further. Existing home sales dropped nearly 4 percent in May to a six-month low, according to data on Tuesday.

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