WRAPUP 7-Fed ties rate pledge to a threshold as new stimulus set
* Fed keeps to $85 bln pace of monthly bond purchases
* Fresh Treasury buying to expand balance sheet
* Fed adopts numerical thresholds in surprise move
WASHINGTON, Dec 12 (Reuters) - The U.S. Federal Reserve, announcing a new round of monetary stimulus, took the unprecedented step on Wednesday of indicating interest rates would remain near zero until unemployment falls to at least 6.5 percent.
It was the latest in a series of unorthodox measures taken by central banks around the world as major economies face erratic, sub-par recoveries from the global financial crisis and recession of 2007-2009.
The Fed said it expects to hold rates steady until its new threshold on unemployment was reached as long as inflation does not threaten to break above 2.5 percent and inflation expectations are contained.
Fed officials, who cut their forecasts for both economic growth and inflation next year, a lso replaced an expiring stimulus program with a fresh round of Treasury debt purchases.
"The committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," the Fed's policy-setting panel said in a statement at the close of a two-day meeting.
Fed officials committed to purchase $45 billion in longer-term Treasuries each month on top of the $40 billion per month in mortgage-backed bonds the U.S. central bank started buying in September. They also repeated a pledge to keep pumping money into the economy until the outlook for the labor market improves "substantially."
The Fed will fund the new Treasury purchases with an expansion of its $2.8 trillion balance sheet. Under the "Operation Twist" program, the Fed bought an identical amount but paid for them with proceeds from sales and redemptions of short-term debt.
Some policymakers view actions that expand the Fed's balance sheet as economically more potent than those that do not. However, Fed Chairman Ben Bernanke told a news conference that the stimulus would remain about the same, given that the central bank is still purchasing a combined $85 billion per month in longer-term securities.
"They see an anemic economy, and they're doing all they can to get any economic progress," said Alan Lancz, president of Alan B. Lancz & Associates in Toledo, Ohio.
The Fed's actions initially gave a small lift to U.S. stocks prices, but the major stock indexes closed mostly unchanged, while government bond prices fell. Oil prices rose and the dollar weakened against the euro.
Fed policymakers voted 11-1 to back the new plan. Jeffrey Lacker, president of the Richmond Federal Reserve Bank, dissented, as he has at every meeting this year, expressing opposition both to the bond buying and the new economic thresholds.
SWEATING A WEAK RECOVERY
The newly unveiled numerical policy guidelines offered the most specific suggestion yet that the Fed is willing to tolerate slightly higher inflation as it tries to juice up a moribund economy and spur stronger job growth.
A drop in the unemployment rate to 7.7 percent in November from 7.9 percent in October was driven by workers exiting the labor force, and therefore did not come close to satisfying the condition the Fed has set for trimming its stimulus.
"Decisions taken today further strengthen the Fed's commitment to generate a stronger recovery and substantially improve conditions in the labor market," said Michael Gapen, an economist at Barclays in New York.
In response to the financial crisis and recession, the Fed slashed overnight rates to zero almost exactly four years ago and bought some $2.4 trillion in mortgage and Treasury securities to keep long-term rates down.
Despite its unconventional and aggressive efforts, U.S. economic growth remains tepid. Gross domestic product grew at a 2.7 percent annual rate in the third quarter, but a Reuters poll published on Wednesday showed economists expect the economy to expand at just a 1.2 percent pace in the current quarter.
Businesses have hunkered down, fearful of a tightening of fiscal policy as politicians in Washington wrangle over ways to avoid a $600 billion mix of spending reductions and expiring tax cuts set to take hold at the start of 2013.
Bernanke has warned that running over this "fiscal cliff" would lead to a new recession. He told reporters the Fed could ramp up its bond buying "a bit," but emphasized that monetary policy has limits and could not fully offset the impact.
NEW TACK ON RATES
By setting thresholds to help guide its decision on when to eventually hike rates, the Fed was able to jettison a previous prediction that borrowing costs would remain at rock bottom levels until at least mid-2015.
Officials were uncomfortable with guidance that relied on a calendar date, and they are hopeful the new framework will help financial markets assess incoming economic data in a way that helps them correctly guess were monetary policy is heading.
Bernanke emphasized that the central bank would look at a range of indicators, not just the rates of unemployment and inflation, in determining when to finally raise rates.
"Reaching the thresholds will not immediately trigger a reduction in policy accommodation," said Bernanke, adding that the central bank would not be on "auto pilot."
"No single indicator provides a complete assessment of the state of the labor market," he said.
The prior practice of fixing an end point was criticized by some economists as sending a message that the Fed expected the economy to be weak until then. Bernanke said the new framework was consistent with the earlier calendar guidance, because officials do not expect the unemployment rate to reach the 6.5 percent threshold level until sometime in 2015.
Indeed, a fresh set of economic projections from the Fed put the jobless rate in a 6 percent to 6.6 percent range in the fourth quarter of 2015. At the same time, the projections showed that at no point over that forecast horizon does the central bank see inflation topping its 2 percent target.
Officials held to their assessment that they could eventually push the jobless rate down to a 5.2 percent to 6 percent range without sparking inflation, although Bernanke cautioned that policy would have to start tightening before it fell so low. In its statement, the Fed said its long-term asset purchase program would end well before any rate hike.
Fed policymakers see GDP expanding between 2.3 percent and 3.0 percent next year. That's down from the 2.5 percent to 3.0 percent they forecast in September, but is still a bit more optimistic than most private forecasters. The Reuters poll of economists found a median U.S. growth estimate of 2.1 percent for next year.