By Steven K. Beckner

WASHINGTON (MNI) – There is mounting talk that the Federal Reserve
needs to tighten monetary policy to curb inflation, but the Fed’s
policymaking Federal Open Market Committee made clear Wednesday that it
is not ready to do so just yet amid continued uncertainty about the
economy.

There were few surprises in the Federal Reserve’s FOMC policy
statement Wednesday, leaving plenty of room for Chairman Ben Bernanke to
embellish on the economic and policy outlook at his upcoming and
first-ever post-FOMC press conference.

As expected, the FOMC unanimously left the overnight federal funds
rate between zero and 25 basis points where it’s been since December
2008. And the FOMC decided to allow the $600 billion program of
long-term Treasury security purchases to run to its conclusion at the
end of June.

What’s more, it maintained its existing policy of reinvesting
proceeds of maturing mortgage backed securities, which has the effect of
preventing any “passive” shrinkage of the balance sheet.

Nor were there any major changes in the policy statement, which was
reworded a good bit at the March 15 meeting to signal a greater Fed
awareness of inflation pressures.

At that time, the FOMC said, “Commodity prices have risen
significantly since the summer, and concerns about global supplies of
crude oil have contributed to a sharp run-up in oil prices in recent
weeks. Nonetheless, longer-term inflation expectations have remained
stable, and measures of underlying inflation have been subdued.”

The March 15 statement went on to say, “The recent increases in the
prices of energy and other commodities are currently putting upward
pressure on inflation. The Committee expects these effects to be
transitory, but it will pay close attention to the evolution of
inflation and inflation expectations.”

The Fed did add, more assertively, that “inflation has picked up in
recent months,” and it pointed to “further” increases in oil prices
since the March meeting. But the main thrust of the FOMC’s comments on
inflation was much as before.

More significantly, perhaps, is that the FOMC toned down its
evaluation of the economy somewhat, dropping its March assertion that
“the economic recovery is on a firmer footing” and replacing it with a
less ebullient observation that “the economic recovery is proceeding at a
moderate pace and overall conditions in the labor market are improving
gradually.” (Last time, the FOMC said that labor market conditions
“appear to be improving gradually.” )

This was the FOMC’s last opportunity — at least at a regularly
scheduled meeting — to cut short the second round of quantitative
easing (“QE2″). Some Fed presidents had advocated doing just that to
begin the process of normalizing an extraordinarily lax monetary policy,
pointing out that deflation concerns have all but disappeared and the
economy appears on a self-sustaining path.

Notably, although the end of QE2 is on the horizon, the FOMC
retained its pledge to “regularly review the pace of its securities
purchases and the overall size of the asset-purchase program in light of
incoming information” and said it is “prepared to adjust those holdings
as needed to best foster maximum employment and price stability.”

The FOMC thus seemed to hold open the possibility that it could
prematurely end QE2 between now and the late June meeting or make other
changes in the balance sheet. For instance, it could discontinue its
practice of reinvesting proceeds of maturing MBS. This doesn’t seem
likely, however.

The fact that the FOMC decided to complete QE2 would seem to
reflect lingering concern about the state of the economy and the level
of unemployment, though not about disinflation. It may also reflect a
desire, at this point, not to disrupt an already nervous bond market.

The basic problem for the FOMC is that, while higher food, gasoline
and other commodity prices exert inflationary pressures, they also have
a retarding effect on economic growth. The majority opinion among FOMC
policymakers is that, so long as inflation expectations are
“well-anchored,” the Fed can afford to remain accommodative of growth.
Hence the unchanged policy.

There is nothing in the statement that suggests an inclination,
once QE2 has been completed, to proceed with a “QE3.” But it wasn’t
ruled out. The FOMC reiterated that it “will continue to monitor the
economic outlook and financial developments and will employ its policy
tools as necessary to support the economic recovery and to help ensure
that inflation, over time, is at levels consistent with its mandate.”

But unless some shock, like a further sharp rise in oil prices,
undermines the recovery, the issue in coming months will not be whether
further easing is done but when tightening begins.

The FOMC’s characterization of economic conditions and inflation
does not differ greatly from the March 15 statement. But it does vary
significantly from the statement issued following the January meeting,
when the Committee last did its quarterly, three year forecasting
exercise.

Since then unemployment has dipped even though the pace of GDP
growth has slowed, and inflation has picked up. So the FOMC’s revised
projections are apt to reflect those changes when they are released in
advance of Bernanke’s 2:15 p.m. press conference.

Bernanke will have a chance to expound on those economic
projections and their implications for monetary policy. The FOMC is
believed to have explored its “exit strategy” options, and the chairman
will likely be asked about that as well.

It is highly doubtful, however, whether Bernanke will give any very
definite ideas about when the Fed will start tightening monetary policy,
either through interest rate hikes or through passive or active
shrinkage of the Fed’s balance sheet and in turn bank reserves.

** Market News International Washington Bureau: 202-371-2121 **

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