Fed Seen Affirming QE2 Plan, No Rush to Exit

The Federal Reserve looks certain to stick to its plan to complete its $600 billion bond-buying program at a meeting next week, and is unlikely to rush to tighten policy given an uncertain economic outlook.

Many analysts believe the U.S. central bank will hold the size of its balance sheet steady by reinvesting maturing assets after June to avoid a passive tightening -- an issue that will likely be discussed at the April 26-27 meeting.

"Usually what the Fed does is they ease, then they stay on hold and then they tighten," said Roberto Perli, managing director of policy research at ISI in Washington and a former Fed staffer. "I do expect the balance sheet will remain constant for a while."

A backdrop of softer-than-expected economic data, weak housing markets and possible government austerity measures to tackle the budget deficit all make it more likely the Fed will keep its support for the recovery in place for some time.

Although a jump in oil prices has pushed headline inflation higher, the most influential Fed officials -- including Chairman Ben Bernanke -- see the rise as transitory.

Still, the Fed is likely to discuss how it will eventually exit from its extremely easy monetary policy. It has kept overnight interest rates near zero since December 2008 and is on track to wrap up the purchase of about $2.3 trillion in bonds in its effort to keep borrowing costs low.

Some of the more hawkish Fed officials have argued in recent weeks that the central bank needs to detail how it will withdraw this extraordinary economic support.

BIDING ITS TIME

The Fed's holding pattern puts it at odds with other central banks around the world, most notably the European Central Bank, which raised euro zone interest rates this month, ending almost two years of record low borrowing costs.

While the Fed is not planning to expand its latest $600 billion bout of bond purchases, few analysts doubt it will complete the program. Michael Gapen, an economist at Barclays Capital in New York and a former Fed staffer, said the Fed could underscore this by changing its post-meeting statement to say "will purchase" from "intends to purchase."

At the Fed's last meeting in late March, it said the recovery was on a firm footing. Since then, the economy has been hurt by higher oil prices, which have cut into consumer spending and company earnings.

One of the most influential officials at the central bank, New York Federal Reserve Bank President William Dudley, last month called the recovery still "tenuous" as he touched on an array of risks including political upheaval in the Arab world.

"They want to see that the economy is on a self-sustaining trajectory before they fully tighten policy," said Perli. "If you couple that with all the uncertainty we have in terms of oil prices, likely fiscal tightening, housing that's still poor, all this calls for the Fed to be on hold."

That's not to say Fed officials are all on the same page. The core of the policy-setting committee will likely face some pushback from members who are worried about inflation.

Those officials have been increasingly calling for the Fed to lay out a clear plan for tightening policy, and warning of risks if it drags its feet.

"They are still going to talk tough on inflation, I think that's one of the compromises between the hawks and the doves, even if they won't be tightening policy yet," said Michael Hanson, a senior economist at BofA Merrill Lynch.

Questions about the exit strategy will likely arise when Fed Chairman Ben Bernanke gives his first-ever post-meeting news conference on April 27 and he may use the forum as an opportunity to flesh out Fed thinking on the matter.

Officials have voiced different views on the best way to eventually tighten policy -- for example whether to sell assets before raising rates or vice versa.

Markets will also parse the Fed's quarterly economic forecasts, which will be released alongside the policy statement. Economists are keen to see if the Fed raises its forecast for core inflation, which would suggest increasing nervousness that high oil prices will push other costs higher.