Operation Twist

Fed extends stimulus and warns on US recovery

Ben Bernanke extends Operation Twist stimulus but warns that unemployment is unlikely to improve before end of the year

the Guardian,

20 June, 2012

The US Federal Reserve announced a $267bn (£176bn) plan to underpin the US's fragile recovery Wednesday as chairman Ben Bernanke warned that unemployment was unlikely to improve before the end of the year.

The plan – an extension of a scheme known as Operation Twist – aims to drive down long-term interest rate and encourage borrowing. The announcement came as the latest statement from the Fed painted a gloomier picture of the US economy and said it was prepared to take more action if necessary.

The Fed said that the growth in employment "has slowed in recent months, and the unemployment rate remains elevated," and that household spending "appears to be rising at a somewhat slower pace than earlier in the year." The Fed also reiterated its concern that "strains in global financial markets continue to pose significant downside risks" to growth.

That news will be a blow to the Obama administration in the run-up to an election that looks set to be dominated by economic news in general and the unemployment rate in particular.

At a press conference Bernanke said the Fed had been too optimistic in its projections for recovery, and warned again that Europe was a significant drag on the US recovery.

Even though the Fed said the US recovery appears to be slowing, Bernanke stopped short of a third round of quantitative easing (QE3), a more ambitious – and expensive – stimulus programme. He said: "We still do have considerable scope to do more and we're prepared to do more."

"People are finding jobs, just not at the rate we would like to see," said Bernanke. The Fed is prepared to do more if it thinks necessary, he said but those actions have consequences. "I don't think they should be launched lightly," he said.

The Fed predicted the unemployment rate would be 8% to 8.2%, roughly today's levels, at the end of this year compared with the projection of 7.8% to 8% in its April forecast.

Bernanke warned that political infighting over the so-called "fiscal cliff" could also have dire consequences. On December 31, Bush-era tax cuts are due to expire and if Republicans and Democrats fail to reach a compromise, the US faces steep spending cuts that Mohamed El-Erian, chief executive of investment firm Pimco, has estimated could be equivalent to 4% of GDP.

Bernanke said Europe remained a grave concern. He said it was for European leaders, not the US, to address their issues. "At this point we're mostly just in consultation mode," he said. "We are hoping for the best … but we are prepared in case things get worse to protect the US economy and the US financial system."

"If those risks increase then we suspect the Fed would be pretty quick off the mark in taking more aggressive action," said Paul Ashworth, chief US economist at Capital Economics.

David Semmens, senior US economist at Standard Chartered, said the Fed's actions showed it was "taking the slowdown seriously but they are not concerned about a return to recession."

Gus Faucher, senior macro-economist at PNC Financial, said the move was largely in line with expectations but still left unanswered the big question: "What is the benchmark for QE3?"

The news left Wall Street flat. The Dow Jones ended the day just 0.1% down.