Fed seen maintaining bond-buying, but divisions remain

The Federal Reserve is expected to keep monetary policy on a steady path when it concludes a two-day meeting on Wednesday, though behind the scenes intensive debate continues over when it should curtail its controversial bond-buying program.

The policy statement issued by the U.S. central bank at the end of the meeting will likely be only slightly rephrased from the one in December to reflect minor changes in the economic outlook, notably reduced risks from financial turmoil in Europe.

Otherwise, economists say the policy-setting Federal Open Market Committee will maintain asset buying at $85 billion a month and retain the commitment to hold interest rates near zero percent until the unemployment rate falls to 6.5 percent, provided inflation does not threaten to breach 2.5 percent.

The Fed has taken unprecedented steps to try to spark a stronger economic recovery and drive down unemployment. It has kept overnight interest rates near zero since late 2008 and has launched three rounds of bond purchases, known as quantitative easing, to drive other borrowing costs down.

However, the economy's recovery from the 2007-2009 recession has been stubbornly tepid and data on Friday is expected to show the nation's jobless rate was stuck at 7.8 percent in January.

A report on Wednesday showed U.S. GDP unexpectedly shrank at a 0.1 percent annual pace in the fourth quarter as businesses added to inventories at a slower pace and government spending and exports dropped sharply.

While consumer spending and business investment improved, and a separate report showed 192,000 private-sector jobs were created in January, the data underscored the economy's fragility.

"This report doesn't have immediate implications for Fed policy. They will be unhappy with it, but it's one quarter's number," said Terry Sheenan, an economic analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.


The Fed will issue a statement outlining its policy decision and views on the economy at around 2:15 p.m.

But investors will have to wait three weeks for the release of the meeting's minutes to get a sense of what likely will be a lively discussion on how the central bank should communicate about the future of its current securities purchase program, dubbed QE3.

Critics warn that the bond buying, which has tripled the Fed's balance sheet to almost $3 trillion since 2008, might stoke inflation or trigger an asset bubble that could tip the economy back into recession when it bursts.

Some policymakers advocate adopting set levels of certain economic variables that would signal when the central bank thinks the time is ripe to stop the purchases, much like the "thresholds" it has adopted to help guide the market's understanding of when interest rates are finally likely to rise.

An unexpected halt in the buying, which accounts for a big part of the demand for U.S. Treasury debt, could send long-term borrowing costs shooting up and damage the recovery.

The president of the Boston Federal Reserve Bank, Eric Rosengren, has led the charge for bond-buying thresholds, arguing the central bank should continue the purchases until unemployment falls under 7.25 percent.

Other officials think differently, and it may take months to build a consensus -- if one can even be built.

Since September, when it launched QE3, the Fed has said it would buy bonds until it saw a substantial improvement in the outlook for the labor market, a mark many analysts think won't be reached this year.

More than half of 41 economists polled by Reuters earlier this month expect purchases to continue into 2014.

"They have to see a substantial improvement in the labor market, and they don't forecast one this year," said Stephen Oliner at the American Enterprise Institute in Washington.

But minutes of the Fed's December meeting, released early this month, showed a few policymakers thought the program should be halted by mid-2013, surprising financial markets.

As the first meeting of the year, four voting seats on the policy panel will change hands.

The new voters are Esther George, the Kansas City Fed president; Boston's Rosengren; James Bullard, the St. Louis Fed president; and Chicago Fed President Charles Evans.

George is viewed as a clear hawk and the most likely to dissent against maintaining the bond purchases, while Evans and Rosengren are expected to vote in favor. Bullard's recent comments have been hawkish, but he has not sounded sufficiently uncomfortable with current policy to dissent at this stage.

(Additional reporting by Ellen Freilich; Editing by Leslie Adler, Tim Ahmann and Chizu Nomiyama)