Fed sees risks from Europe, some improvement in U.S.

Federal Reserve Chairman Ben Bernanke delivers opening remarks at a conference on ''Small Business and Entrepreneurship during an Economic Recovery'' at the Federal Reserve in Washington, November 9, 2011.

Credit: Reuters/Hyungwon Kang

By Mark Felsenthal and Pedro da Costa

WASHINGTON | Tue Dec 13, 2011 9:15pm EST

WASHINGTON (Reuters) - The Federal Reserve on Tuesday warned that turmoil in Europe presents a big risk to the U.S. economy, leaving the door open to possible further steps to boost growth even though it noted a somewhat stronger labor market.

The central bank said the U.S. economy was "expanding moderately" despite an apparent slowing in the world economy. But while there had been "some" improvement in the job market, unemployment remained elevated and housing depressed, it said.

"Strains in global financial markets continue to pose significant downside risks to the economic outlook," the Fed said after a policy meeting, alluding to pressures stemming from the debt crisis in the euro zone, which has raised concerns about tighter credit in the United States.

Some investors had speculated that the Fed might show more urgency about moving ahead with new measures to help the economy.

U.S. stock prices fell, while prices for government debt rose. The dollar, which has been pressured by the Fed's huge-bond-buying programs, gained against the euro.

The Fed's statement was little changed from the one made after its last meeting in early November, although the U.S. central bank pinned uncertainty for the U.S. economy more squarely on events in Europe.

While in November it said risks to the outlook included global strains, on Tuesday it cited only the risk of volatility abroad.

Most economists have said the Fed's next meeting on January 24-25 would be the more likely occasion for any new moves to add to the U.S. central bank's already extraordinary push to bring down borrowing costs and help growth.

FOCUSING ON RISKS

Tuesday's statement touched only lightly on signs of improvement in the economy's performance.

"They are certainly ready to lean against the wind should the economy falter," said Cary Leahey, managing director at Decision Economics in New York.

The Fed offered no new guidance on the changing way it communicates its policies to financial markets; Fed Chairman Ben Bernanke has made increased transparency a hallmark of his six years in charge of the central bank.

It also repeated that it expects inflation to settle at levels at or below those consistent with its price stability mandate.

For a second time running, Chicago Fed President Charles Evans dissented against holding policy steady, saying he favored additional easing now.

The U.S. central bank has held overnight interest rates near zero since December 2008 and has bought $2.3 trillion in government and mortgage-related bonds in a further attempt to stimulate a robust recovery.

Fed officials are divided among those who think high unemployment and sluggish growth require more action and those who view the central bank's already-aggressive efforts as bordering dangerously on an invitation to inflation.

Some influential policymakers, including Vice Chair Janet Yellen, have suggested they would be inclined to take additional steps if growth fails to pick up.

LOOKING TO 2012

Changes to the Fed's voting line-up for 2012 will remove three policymakers known to favor a hard line against inflation, while adding only one such "hawk," suggesting support for further easing may strengthen in coming months.

The Fed's activist approach to pulling the economy out of recession and buoying a tepid recovery stands in contrast to the European Central Bank, which has been more tentative. The ECB held interest rates steady until November before delivering two rate cuts as the euro zone began to slide toward economic contraction.

Moreover, ECB President Mario Draghi disappointed financial markets last week by downplaying prospects the central bank would launch an aggressive bond-buying program to ease strains in the region.

So far, the U.S. economy has shown little impact from the events in Europe.

The jobless rate tumbled 0.4 percentage point to 8.6 percent in November, factory activity has quickened and businesses are restocking depleted shelves.

Consumer spending also appears reasonably solid, although a softer-than-expected report on November retail sales on Tuesday offered a hint that spending could be flagging.

The U.S. economy expanded at a 2.0 percent annual rate in the third quarter, a welcome acceleration from a sub-1 percent pace over the first half of the year. Forecasters hope growth will top a 3 percent rate in the current quarter.

However, analysts say the recovery's current strength is partly a snapback from the weakness earlier in the year and caution that a return to more sluggish growth is likely, particularly with a European recession brewing.

INTERNAL DEBATE

Many observers believe the Fed will take steps to stimulate growth in 2012, first through communications measures that drive home the expectation that interest rates will not rise for a long time and then possibly through more bond buying.

Yellen has said the Fed could reinforce its ultra-accommodative monetary stance by publishing policymakers' forecasts for the path of interest rates. Officials are also debating whether to adopt an explicit target for inflation.

The first step would reassure skittish markets that the Fed is not about to tighten policy any time soon. The latter would aim to dispel any doubts about the central bank's commitment to keeping inflation low.

Top officials have also remained open to adding bonds to the central bank's already-bloated portfolio.

Some have said the Fed should resume purchases of mortgage-backed securities to help revive the depressed housing market; others would prefer to stick with purchases of U.S. government debt.

(Additional reporting by David Lawder; Editing by Andrea Ricci, Tim Ahmann and Dan Grebler)

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