Fed shows 'a bit more' optimism in forecast

February 19, 2010

USA TODAY

Paul Davidson

The Federal Reserve slightly upgraded its economic forecast in a report released Wednesday, with the quickening pace of growth prompting some policymakers to argue the central bank should soon take steps to drive up mortgage rates.
But while the minutes of its Jan. 26-27 meeting reveal that several policymakers want to move early to combat inflation, most appear to be aligned with Fed Chairman Ben Bernanke's view that such a move could derail the economic recovery.

The Fed raised its forecast for economic growth this year to 2.8% to 3.5%, up from 2.5% to 3.5% in November. A better-than-expected report Wednesday on industrial production last month seemed to support a brighter outlook.

The central bank largely cited businesses' growing reluctance to draw down depleted inventories, a stance that's forcing them to ratchet up production to meet demand. Policymakers added that "economic growth had strengthened in the fourth quarter, that firms were reducing payrolls at a less rapid pace, and that downside risks to the outlook for economic growth had diminished a bit further."

At the same time, the Fed said economic and job growth would be "slow relative to past recoveries from deep recessions." That's largely because consumer spending, though stabilized after plummeting during the recession, has not taken off.

The central bank marginally raised its 2010 year-end unemployment outlook to 9.5% to 9.7% from 9.3% to 9.7%. The jobless rate is 9.7%. Its inflation forecast edged up to 1.1% to 1.7%, from 1% to 1.5%.

The specter of inflation is prompting some policymakers to argue that the Fed should soon sell the $1.25 trillion in mortgage securities it is purchasing, a maneuver that has driven down borrowing costs for home buyers. "Several (policymakers) thought it important" to begin asset sales soon and conduct them "at a pace that would keep inflation contained," the minutes said.

Such securities sales, which likely would drive up mortgage rates, have been supported recently by two Fed policymakers, including Federal Reserve Bank of Philadelphia President Charles Plosser on Wednesday.

But "many were concerned" that the maneuver could have "adverse implications for the economic recovery," the minutes said. That suggests most policymakers agree with Bernanke, who said last week that security sales would not take place until after the recovery is on firmer footing and the Fed raises short-term interest rates, says economist John Canally of LPL Financial.

The minutes also reveal why Federal Reserve Bank of Kansas City President Thomas Hoenig was the lone dissenter to the Fed policy statement last month. He opposed the majority view that interest rates likely would stay near zero "for an extended period." Citing the improving economy and the inflation threat, he said the Fed instead should have said rates would be low "for some time."

In a separate report, the Fed said industrial production rose a better-than-expected 0.9% in January from the previous month, with gains across a broad range of sectors.

Auto production led the way with a 4.9% jump. But output also rose 0.8% for all goods excluding motor vehicles. For example, consumer goods were up 1.1%; business equipment, up 0.9%; and high-tech gear, up 1.9%.

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