Fed minutes: Some ready to ease if recovery lags

Some Federal Reserve officials believe further monetary policy easing could be needed if the recovery remains too sluggish to cut the stubbornly high U.S. jobless rate and if inflation eases as expected, minutes of the Fed's last meeting show.

The minutes of the June meeting, which were released on Tuesday, offered the strongest suggestion since the Fed's $600 billion bond-buying program ended on June 30 that there could be consideration of a third round of quantitative easing.

Although the minutes showed officials were concerned that continued weak growth could undercut the two-year-old recovery, not all policy makers were convinced renewed stimulus is needed. A few held the opposite view, saying that if recent increases in inflation do not moderate, the Fed should consider tightening policy sooner than expected.

All the Fed policy makers viewed the recovery as having slowed since their April forecasts and said recent deterioration in labor market conditions was a particular concern because it could weigh on consumer spending.

The last Fed policy meeting took place June 21-22, before a government report showed employers added a scant 18,000 jobs in June.

At last month's meeting, the Fed decided to wind down the second installment of asset purchases that have totaled $2.4 trillion as scheduled. It further signaled it is in no rush to tighten policy in the face of lofty unemployment over 9 percent and tepid growth.

Most analysts expect the Fed's next move to be to raise interest rates rather than to offer more stimulus by buying bonds or bolstering its promise to keep rates at rock-bottom levels. The Fed is not expected to raise rates until the middle of next year.

This just emphasizes to me that it will be quite some time before they're moving, said Dean Maki of Barclays Capital.

U.S. stocks rose and the euro gained strength after the Fed minutes suggested the potential for more monetary policy support at a later date. The gains were small, however, and only lasted a short time.

People were expecting a flat-out, 'No this is it. This is the end of the line,' and the fact that the door is still a little bit open provides a little bit of hope, said Peter Jankovskis, co-chief investment officer of OakBrook Investments LLC in Lisle, Illinois.

Fed Chairman Ben Bernanke is due to face members of Congress over two days of semi-annual testimony about monetary policy on Wednesday and Thursday and is likely to provide more details about the internal Fed debate.

DEBT CEILING WARNING

In addressing the looming August 2 deadline to raise the debt ceiling, the Fed was blunt in warning on the risks, saying a failure to act by the deadline would result in an inability of the United States to pay some of its obligations.

Even a short delay in the payment of principal or interest on the Treasury Department's debt obligations would likely cause severe market disruptions and could also have a lasting effect on U.S. borrowing costs, the Fed minutes read.

Officials also noted that investors had become more concerned about risks. They pointed to an escalation of debt problems in Greece and other European countries, as well as the debt ceiling fight playing out between Congress and the White House.

The minutes revealed a Fed divided not only over whether to prepare for more easing or for tightening, but over risks from inflation. While most officials expected recent increases in inflation would recede as commodity prices remain stable, some saw inflation risks to the upside.

Some also viewed the Fed's own ultra-loose monetary policy stance -- benchmark rates have been near zero since December 2008 and the central bank has roughly tripled its balance sheet from pre-crisis levels -- as itself posing risks to inflation and of creating an inflationary psychology.

The central bank took the unusual steps of agreeing on two sets of principles: one on an eventual strategy, the other on rules governing communications by Fed officials.

Policy makers agreed that they would likely begin any tightening process by stopping reinvestments of maturing bonds in its portfolio, accompanied by, or shortly followed by, an end to its promise to hold benchmark rates extremely low for an extended period.

Temporary reserve-draining steps would likely accompany those steps. When conditions warrant, the Fed would raise benchmark rates.

As it raised rates, the Fed would also adjust the interest rate it pays banks on excess reserves as well as the level of reserves in the banking system.

Actual sales of assets would likely come sometime after the first increase in benchmark interest rates, the Fed said.

All but one Fed officials agreed to the exit strategy principles.

(Reporting by Mark Felsenthal and Pedro Nicolaci da Costa; Editing by Leslie Adler)