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June 30, 2009

Success of U.S. federal stimulus brings inflation concerns


With signs the U.S. economy is improving but still fragile, Federal Reserve policymakers are considering whether some programs intended to drive down rates on mortgages and other consumer debt should be slowed down.

Fears have grown on Wall Street that the Fed’s radical efforts to lift the country out of the longest recession since World War II could ignite inflation later on.

“Injecting additional money into the banking system is a pretty dangerous game right now, and the Fed cannot afford to press on the accelerator amid a potentially inflationary environment,” said Richard Yamarone, economist at Argus Research.

Wanting to snuff out any rise in inflation expectations, the Fed could opt to tweak its already-announced programs to slow down purchases of either government debt or mortgage-backed securities. Doing so also could help avert possible market disruptions and make it easier for the Fed to reel in these programs once the economy rebounds.

In March, the Fed launched a bold US$1.2 trillion effort to drive down interest rates to try to revive lending and get Americans to spend more freely again. It said it would spend up to US$300 billion to buy long-term government bonds over six months and boost its purchases of mortgage securities. So far, the Fed has bought about US$177.5 billion in Treasury bonds.

The Fed is on track to buy up to US$1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year or early next year. Nearly US$456 billion worth of those securities have been purchased.

But slowing down the purchases carries risk, including that rates on mortgages and government debt could rise more than expected, which could hurt the economy’s prospects for emerging from recession, economists said.

A recent run-up in rates on mortgages and Treasury securities, if prolonged, could choke off prospects for an economic recovery. Some of those fears were eased recently, when rates on 30-year mortgages dipped to 5.38 per cent after a string of weekly increases.

A fresh sign of the economy’s improvement emerged Wednesday. Orders placed with factories for costly goods grew 1.8 per cent for the second straight month in May, and a barometer of business investment posted its largest gain in nearly five years, the Commerce Department reported.

Another government report showed that new-home sales dipped slightly in May, a sign the housing market’s recovery will be gradual. Sales of previously owned homes nudged up in May, according to a report June 23 from the National Association of Realtors.

Meanwhile, the Fed is all but certain to hold its key bank lending rate at a record low between zero and 0.25 per cent when the most recent meeting concludes and probably through the rest of this year, economists said.

That means commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay around 3.25 per cent, the lowest in decades.

Bernanke has predicted the recession will end later this year. Some analysts say the economy will start growing again as soon as the July-September quarter as the Fed’s actions so far take effect.

There have been other promising signs of late: construction activity has picked up — albeit off record-low levels; consumer spending has stabilized following a massive cutback at the end of last year; layoffs are slowing and some credit stresses have eased.

Even after the recession ends, the recovery is likely to be tepid, which will push unemployment higher.

The U.S. unemployment rate — now at 9.4 per cent — is expected to keep climbing into 2010.

Associated Press

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