Doubt stayed Fed hand on more asset buying

The Federal Reserve held fire on additional asset purchases at its meeting last month because of doubts about how financial markets would react to more buying, documents on Wednesday showed.

Fed officials judged that the country's severe recession was coming to an end, and they bumped up forecasts for economic activity for both this year and next. However, policy-makers also sharply raised projections for unemployment and determined that downside economic risks remained.

Despite this risk, they opted not to boost an existing $1.75 trillion asset purchase program -- currently their main tool for spurring the economy -- out of worry this could do more harm than good.

Although an expansion of such purchases might provide additional support to the economy, the effects of further asset purchases, especially of Treasury securities, on the economy and on inflation expectations were uncertain, minutes of the Fed's June 23-24 meeting said.

Long-term bond yields had risen somewhat in the weeks before the meeting, with some blaming the change on fears among investors that the Fed would monetize the debt -- purchase U.S. government bonds with newly created money to help it finance a record budget deficit.

Policy-makers did not think that U.S. Treasury purchases would leak into higher inflation, but noted that public perceptions about debt monetization could impact expectations.

Analysts said the Fed was signaling that it would probably not now boost unconventional quantitative easing measures going forward, a stance also seen being adopted by the Bank of England, after it held its U.K. gilt purchase program at 125 billion pounds at a meeting last week.

(Fed) officials are unlikely to countenance any further expansion of the long-term asset purchase program, said Paul Ashworth, senior U.S. economist at Capital Economics, Toronto.

A small scale increase in Treasury purchases was ruled out because officials thought it would be a futile move given the massive increases in supply and have little, if any, impact on long-term interest rates, he said in a note to clients.

The Fed also held interest rates in a range of zero to 0.25 percent at the meeting, and repeated an assurance that rates would remain exceptionally low for an extended period.

With rates about as low as they can go, asset purchases are now a key tool in the U.S. central bank's arsenal to stimulate growth, and it has already doubled its balance sheet to around $2 trillion to support the economy.

But policy-makers felt that with a massive purchase program already in train -- $300 billion of longer dated Treasuries to be bought by end-September and $1.45 trillion of mortgage debt by end-December -- they had done enough for now.

Moreover, it seemed likely that economic activity was in the process of leveling out, and the considerable improvements in financial markets over recent months were likely to lend further support to aggregate demand, the Fed said.

Policy-makers slightly raised their outlook for the economy in 2009, but projected that unemployment could push above 10 percent, and then only decline slowly over the next 12 months.

Labor market conditions were of particular concern to meeting participants, the Fed said, noting that these could weigh on consumer spending and potentially hurt the recovery.

In this light, and with core inflation expected to remain subdued for some time, the policy-makers remained very wary.

Most believed that downside risks to economic growth had diminished somewhat since the April meeting, but were still significant, the Fed said.

Policy-makers also thought that it would take five to six years before the economy would get back to a path where growth, inflation and unemployment were all around long-term trend sustainable levels.

Given such slack, there was scant talk in the minutes of an exit from the Fed's massive monetary stimulus, although it did say that it had the tools needed to manage the balance sheet.

Ensuring that policy accommodation can ultimately be withdrawn smoothly and at the appropriate time would remain a top priority for the Federal Reserve, the minutes said.

(Editing by James Dalgleish)