Fed makes clear that it wants to boost inflation

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Treasury bond yields tumbled Tuesday after Federal Reserve policymakers signaled concern that inflation has fallen too low, and that they stand ready to take more action to keep the economy from weakening further.

That action most likely would be a big new round of Treasury bond purchases, with the goal of driving longer-term interest rates lower.

The yield on the 10-year Treasury note, a benchmark for mortgage rates and other long-term rates, slumped to a two-week low of 2.60% by 12:45 p.m. PDT from 2.70% on Monday. The two-year T-note yield fell to a record low of 0.43% from 0.46% on Monday.

The Fed tweaked its post-meeting statement to say that “measures of underlying inflation are currently at levels somewhat below those the committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”

By contrast, the statement after the Fed’s Aug. 10 meeting sounded less concerned about ebbing inflation, saying that “measures of underlying inflation have trended lower in recent quarters.”

The risk that inflation could go negative -- meaning the U.S. would experience deflation, or a broad-based decline in prices -- has been a hot topic on Wall Street in recent months. The “core” consumer price index, which measures prices excluding food and energy costs, has been running at a mere 0.9% year-over-year rate for the last five months, the smallest increase in 44 years.

The Fed’s statement shows that “deflation is a concern affecting the future course of monetary policy,” said Sung Won Sohn, an economics professor at Cal State Channel Islands.

Policymakers fear deflation because it could lead to a downward spiral of prices and wages that could be difficult or impossible to reverse. If consumers believe prices of goods and services will only get cheaper, they would be likely to defer purchases, potentially making deflation a self-fulfilling prophecy.

By pumping massive new sums into the financial system via bond purchases, the Fed would hope to fuel a rise in money in circulation and thereby stoke inflation. Lower Treasury bond yields also could mean lower mortgage rates, allowing more homeowners to refinance and gain new spending power.

In its statement, the Fed didn’t commit to more Treasury bond purchases but said it was “prepared to provide additional accommodation if needed to support the economic recovery.” That was a change from the statement at the last meeting, when the Fed said it would “employ its policy tools as necessary.”

Some analysts said the wording shift suggests that the Fed is likely to launch a major bond-buying program before the end of the year, perhaps committing to buy upward of $1 trillion of Treasury debt in the open market. The Fed started a more modest round of bond purchases last month.

The statement “demonstrated a strong bias toward easing” further, said Zach Pandl, an economist at Nomura Securities in New York.

-- Tom Petruno

The full Fed statement follows:

Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.

Voting against the policy was Thomas M. Hoenig, who judged that the economy continues to recover at a moderate pace. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and will lead to future imbalances that undermine stable long-run growth. In addition, given economic and financial conditions, Mr. Hoenig did not believe that continuing to reinvest principal payments from its securities holdings was required to support the Committee’s policy objectives.
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