As risks mount, Fed to stick to zero rates policy

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WHAT: Federal Reserve holds monetary policy meetingWHEN: June 22-23; decision June 23, around 2:15 p.m.REUTERS FORECAST: Primary dealers see no change in rates, and believe the Fed will reiterate its commitment to keeping interest rates "exceptionally low" for an "extended period."FACTORS TO WATCH:With the Fed set to stay the course on rates, investors will try to read the tea leaves by digging through any minor changes to the language of the post-meeting statement outlining the U.S. central bank's views on the economy and policy.Here are things to look for:* Extended Period: The language stays in all likelihood. Thomas Hoenig of the Kansas City Fed has dissented at the last three meetings over the issue, believing the open-ended commitment to low rates might create bubbles and other financial imbalances. But with financial markets looking rickety again, that argument becomes more difficult to make. With no change expected here, markets will parse especially closely the Fed's assessment of economic conditions.* Employment: The job outlook remains quite grim, something Fed officials have repeatedly flagged as a key concern. The economy has added new jobs for six of the last seven months, but May's private employment gains proved disappointing, with most of the rise in payrolls coming from temporary U.S. census hires. The jobless rate, at 9.7 percent, is still very high by historical standards. Moreover, weekly initial jobless claims have not budged much. Last week, they rose to 472,000. That means the Fed could refrain from upgrading its characterization of the labor market as "beginning to improve."* Inflation: The near-term outlook for U.S. inflation is very tame. All key indicators have been showing soft price pressures. In fact, some have started to indicate a potentially worrisome return to that perilous gray area between disinflation and outright deflation. The Labor Department's consumer price index excluding food and energy rose just 0.9 percent year-on-year through May. The Cleveland Fed's median CPI, another core inflation measure that excludes outliers, has been flat for five straight months and is up just 0.5 percent in the year to May. Many Fed officials say they are not concerned about deflation at the moment, but a renewed credit crunch and a concomitant hit to the economy's expansion could alter that picture. Some, however, have worried that the Fed's bloated balance sheet could spark inflation down the road. This key sentence probably stays intact: "With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time."* Financial Markets: The Fed could give a nod to recent disruptions in financial markets, which have pushed the cost of interbank borrowing near its highest levels in a year. In April, the central bank said that "while bank lending continues to contract, financial market conditions remain supportive of economic growth." With European banks having run into some trouble, Fed officials may temper that view.* Asset Sales: Before the Fed's April meeting, there was much speculation about whether the central bank might soon embark on a program to sell some of the assets it acquired battling the financial crisis as the first step to tighter financial conditions. The minutes of that meeting did reveal some detailed discussion of the matter. But various pronouncements from key officials at the Fed's board have made it appear unlikely that such a plan would be implemented any time soon.* Discount Rate: Three regional Fed bank boards ahead of the last policy gathering had called for the central bank to further raise the rate it charges for emergency loans at the discount window. The Fed had increased the discount rate by a quarter point to 0.75 percent in February. However, any such move is unlikely for now since there is internal disagreement within the central bank about whether it makes sense to bring the spread between it and the benchmark federal funds rate back to the 100 basis points seen before the crisis.MARKET IMPACT: Investors are much more focused on developments in Europe at the moment, making it unlikely that financial markets will see major ripples following the Fed's decision. However, a bearish economic assessment from the central bank, or any sign that the Fed is overtly worried about inflation getting too low, could put some pressure on stocks, serving as a reminder that the economic recovery is still vulnerable. Falling equities, in turn, could give the dollar and Treasury bond prices a boost.Fed balance sheet graphic http://link.reuters.com/buf92kFed's website www.federalreserve.gov
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