Fed Points to Risks from Europe

(REUTERS)-The Federal Reserve on Tuesday pointed to turmoil in Europe as a big risk to the U.S. economy, leaving the door open to a further easing of monetary policy even as it noted some improvement in the U.S. labor market.

The central bank characterized the U.S. economy as expanding moderately despite an apparent slowing in global growth and said that while there had been some improvement in the job market, unemployment remained elevated and housing depressed.

Strains in global financial markets continue to pose significant downside risks to the economic outlook, the Fed said, alluding in a post-meeting statement to pressures stemming from the debt crisis in the euro zone.

Prices for U.S. stocks and government debt pared gains, while the dollar rose against the euro after the announcement.

The Fed's statement, issued after a one-day meeting, was little changed from the announcement it released after its last gathering in early November, and it touched only lightly on apparent improvements in the economy's performance.

They are certainly ready to lean against the wind should the economy falter, said Cary Leahey, managing director at Decision Economics in New York.

EVANS DISSENTS AGAIN

The Fed offered no new guidance on its evolving communications policy and repeated that it expects inflation to settle at levels at or below those consistent with its price stability mandate.

For a second consecutive meeting, Chicago Fed President Charles Evans dissented against holding policy steady, saying he favored additional easing now.

However, the Fed pinned uncertainty more squarely on events in Europe. While in November it said risks to the outlook merely included global strains, on Tuesday it linked risks directly to volatility abroad.

The U.S. central bank has held overnight interest rates near zero since December 2008 and has bought $2.3 trillion in government and mortgage-related bonds in a further attempt to stimulate a robust recovery.

Fed officials are divided among those who think high unemployment and sluggish growth require more action and those who view the central bank's already-aggressive efforts as bordering dangerously on an invitation to inflation.

Some influential policymakers, including Vice Chair Janet Yellen, have suggested they would be inclined to take additional steps if growth fails to pick up.

Changes to the Fed's voting line-up for 2012 will remove three policymakers known to favor a hard line against inflation, with only one such hawk, Richmond Fed President Jeffrey Lacker, suggesting support for further easing may strengthen in coming months.

The Fed's activist approach to pulling the economy out of recession and to buoying a tepid recovery stands in contrast to the European Central Bank, which has been more tentative. The ECB held rates steady until November before delivering two rate cuts as the euro zone began to slide toward economic contraction.

Moreover, ECB President Mario Draghi disappointed financial markets last week by downplaying prospects the central bank would launch an aggressive bond-buying program to ease strains in the region.

Recent data on the U.S. economy point to some improvement. The jobless rate tumbled 0.4 percentage point to 8.6 percent in November, factory activity has quickened and businesses are restocking depleted shelves.

Consumer spending also appears reasonably solid, although a softer-than-expected report on November retail sales on Tuesday offered a hint that it could be flagging.

The U.S. economy expanded at a 2.0 percent annual rate in the third quarter, a welcome acceleration from a sub-1 percent pace over the first half of the year. Forecasters hope growth will top a 3 percent rate in the current quarter.

However, analysts say the recovery's current strength is partly a snapback from the weakness that followed Japan's natural disasters and high oil prices early in the year.

They caution that a return to more-sluggish growth is likely, particularly with a recession brewing in Europe.

Many observers believe the Fed will take steps to stimulate growth in 2012, first through communications measures that drive home the expectation that interest rates will not rise for a long time, and then through more bond buying.

Yellen has said the Fed could reinforce its ultra-accommodative monetary stance by publishing policymakers' forecasts for the path of interest rates. Officials are also debating whether to adopt an explicit target for inflation.

The first step would reassure skittish markets that the Fed is not about to tighten policy any time soon. The latter would aim to dispel any doubts about the central bank's commitment to keeping inflation low.

Top officials have also remained open to adding bonds to the Fed's already bloated portfolio.

Some have said the central bank should resume purchases of mortgage-backed securities to help revive the depressed housing market; others would prefer to stick with purchases of U.S. government debt.