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Fed set to give economy therapy, not shock treatment

Sep 14, 2011, 4:56 a.m.
Chairman of the Federal Reserve Ben Bernanke reacts while testifying before the Senate Banking, Housing and Urban Affairs Committee about "The Semiannual Monetary Policy Report to the Congress" on Capitol Hill in Washington, July 14, 2011. REUTERS/Larry Downing

By Mark Felsenthal

WASHINGTON (Reuters) - The Federal Reserve, facing rising global financial strains and recession fears, is poised to increase downward pressure on longer-term interest rates next week in a bid to accelerate a sputtering U.S. recovery.

With one eye on escalating debt turmoil in Europe and another on a stubbornly high 9.1 percent U.S. unemployment rate, the Fed, whose policy panel meets next Tuesday and Wednesday, looks set to begin shifting the composition of its balance sheet to weight it more heavily with longer-term securities.

Having taken short-term interest rates to near zero and bloated its balance sheet with bond purchases that topped $2 trillion, analysts say the U.S. central bank is looking for smaller-bore ways to increase its support, such as shifting its holdings away from shorter-term debt.

"That sends a signal the Fed is still active in supporting growth," said Michelle Meyer, an economist for Bank of America Merrill Lynch.

A torrent of weak U.S. economic data has dashed hopes for a robust second half of the year after a disappointingly weak start, casting a shadow over the meeting.

U.S. growth advanced by less than a 1 percent annual rate in the first half of 2011, and Fed officials have acknowledged a need to downgrade their forecasts.

As prospects for a robust recovery crumbled over the summer, Fed Chairman Ben Bernanke announced in late August that policymakers would expand their September meeting from one day to two. Officials will use the time to haggle over what, if any, action to take to prop up the recovery.

DETERIORATING OUTLOOK

In the United States, a debt downgrade after a bruising political battle over raising the nation's borrowing limit has chilled business and consumer confidence. Employers added no jobs on net in August, a blow to hopes for an upswing in hiring.

At the same time, Europe's debt crisis has intensified, pressuring European banks and scaring investors away from risk around the world. U.S. President Barack Obama on Tuesday pressed the euro zone's major countries to take firmer control of the situation, and Treasury Secretary Timothy Geithner announced plans to attend a euro zone finance ministers' meeting in Wroclaw, Poland on Friday.

Other central banks have had to shift their policy focus in response to the dimming outlook. The European Central Bank took no action last week after a series of rate hikes, while the central banks of Canada, South Korea and Indonesia, among others, opted against removing any policy stimulus.

NO, NO, NO

With storm clouds looming, Fed sentiment looks to have coalesced around some form of reshaping the Fed's $2.8 trillion balance sheet to hold more longer-term securities.

Officials hope the move will push down longer-term interest rates, helping encourage home refinancing and business spending. By lowering long-term yields on U.S. debt, the Fed may also push investors to seek higher returns by shifting to stocks or corporate bonds.

Policymakers are likely to discuss some more extreme alternatives -- such as targeting desirable levels for employment or growth, or adopting a policy that would let them overshoot their inflation target -- but those options would likely be reserved in case the economic situation turns even more dire.

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