No talk of exit strategy as Fed holds rate near zero

WASHINGTON -- If Ben Bernanke is pondering a graceful exit from all the easy money on the table, he isn't tipping his hand just yet.

Mr. Bernanke and his colleagues on the U.S. Federal Reserve's open market committee voted unanimously yesterday to stay the course on everything the Fed has been doing to bolster the economy, including buying up large quantities of government Treasury bonds and keeping interest rates near zero.

By doing nothing, the Fed has dampened expectations among many investors that it might soon have to raise interest rates and unwind large-scale purchases of government and mortgage bonds.

"They clearly want to dampen talk of tightening," remarked Ian Shepherdson, chief North American economist at High Frequency Economics in Valhalla, N.Y.

Unlike financial markets, the Fed "sees little reason to adjust rates in the near term," agreed David Resler, chief economist at Nomura Securities in New York.

The committee also stopped short of setting a clear time-frame for starting to shut off the monetary spigot, as the Bank of Canada has done.

In a statement released at the conclusion of the committee's two-day meeting in Washington, the Fed painted a picture of an economy that, while stabilizing, will need large quantities of stimulus for a while yet. The Fed's benchmark short-term interest rate has been set at zero to 0.25 per cent since December.

The Fed acknowledged that the economy would probably stay weak "for a time," but the committee expressed confidence its policies will ultimately "contribute to a gradual resumption of sustainable economic growth," without stoking inflation.

A recent spike in yields on longer-term government bonds had triggered speculation the Fed might have to start looking at an exit strategy from all the cash it has pumped into the economy, either by raising interest rates or shrinking its $2-trillion (U.S.) balance sheet.

The Fed offered a brief synopsis of economic conditions, based on a revised forecast that will be made public in early July. It pointed out that the "pace of economic contraction is slowing" and that household spending is continuing to stabilize.

However, the committee pointed out that job losses, falling home prices and tight credit would keep consumers in a conservative mood for the time being. It also pointed out that businesses are cutting back investments and jobs, while "making progress in bringing inventory stocks into better alignment with sales."

Most economists believe the world's largest economy continued to shrink in the second quarter, but more slowly than big declines experienced in the January to March period (down 5.7 per cent) and the final quarter of 2008 (down 6.3 per cent).

The Fed is walking a fine line between convincing people that it's going to continue doing everything possible to bolster the sluggish economy, while reassuring investors it won't let inflation get out of hand, Scotiabank economist Derek Holt explained in a research report this week.

He suggested it's too early for Mr. Bernanke to signal a shift in tactics.

"Talking exit strategies at this point is like being down in the bottom of the fourth inning and thinking about who will be the closer," Mr. Holt said. "It's grossly premature."

The more immediate challenge for the Fed is that near-zero short-term rates and various programs to expand the money supply aren't yet spurring demand for loans, he added.

Moody's Economy.com economist Ryan Sweet said Mr. Bernanke is clearly eager not to repeat the mistakes of the Great Depression, when the Fed "prematurely shifted" to tighter money and triggered a double-dip slump. So timing is critical, he said.

"The current Fed must not give in to pressure to remove its stimulus measures, lest it short-circuit the recovery," Mr. Sweet added.

There was more evidence yesterday that easy money isn't yet having much of an effect in the housing market. Sales of newly built homes unexpectedly fell 0.6 per cent in May to an annual rate of 342,000, according to the U.S. Census Bureau. Most economists had expected sales to rise.

The inventory of unsold homes fell to its lowest level in a decade. But at the current rate of sales, it will take nearly 10.2 months to work off the overhang.

Mr. Bernanke is due to testify before a Congressional committee today to answer complaints that he strong-armed Bank of America into buying troubled brokerage Merrill Lynch last year.