Fed to hold off on easing, finalize policy framework

WASHINGTON (Reuters) - The Federal Reserve looks set to hold off on easing monetary policy for a second meeting in a row as it gauges the impact of Europe's crisis on the U.S. economy and ponders additional transparency steps.

The central bank has signaled it is close to wrapping up a months-long effort to revamp or beef up its communications strategy.

It appears to be closing in on a decision to use its quarterly economic forecasts as a way to tell markets what they see as the likely paths of inflation, unemployment and even interest rates themselves.

But analysts say the policy-setting Federal Open Market Committee has no reason to pull the trigger now given recent data showing moderately stronger economic growth and the fact that its next set of projections is not due until next month.

"The FOMC seems poised to revamp its communications strategy, but we aren't expecting any bold moves at next week's meeting," said Dana Saporta, an economist at Credit Suisse.

There is debate within the central bank as to whether such guidance would actively constitute an easier stance of monetary policy or merely greater clarity as to policymakers' outlooks.

To be sure, if official forecasts for benchmark interest rates prove to be even more dovish than markets now expect, then market-set rates could fall as investors re-price assets to take this new information into account.

As for further asset purchases, another remaining option in the Fed's arsenal, policymakers appear to want to keep their powder dry in case Europe's debt debacle is not resolved and it triggers a credit crunch that cripples U.S. financial markets.

"The scary scenario of course is if there was an implosion of the financial markets in Europe which would freeze funding markets for everyone," Philadelphia Federal Reserve Bank President Charles Plosser told a news conference on Friday.

"There, it's appropriate and important that central banks around the world be prepared to play (their) role as a lender of last resort and keep financial markets functioning," he said.

Global central banks already took coordinated action to address burgeoning funding pressures in the European financial sector, moving last week to lower the cost of dollar funding available to banks.

For now, however, U.S. economic data have proven reliably solid of late, even if a big drop in the jobless rate to 8.6 percent last month was largely due to workers dropping out of the labor force.

The apparent strengthening in the U.S. recovery buys the Fed time to hold pat on policy while it assesses the potential spillover from the crisis in Europe.

"The U.S. economy has remained quite resilient, so the Fed's tools will likely be kept in their tool belt for the time being," said Jason Ware, a market strategist at Albion Financial Group.

Investors were cautiously hopeful a European summit this week would lay a path out of the region's debt morass, but they remain aware that numerous earlier efforts had failed to stem mounting financial pressures.

PARSING LANGUAGE

In the absence of big policy moves, traders will be left with interpreting the tone of the Fed's assessment of the economy.

At their last meeting in early November, officials described the recovery as having "strengthened somewhat" in the third quarter.

But forecasts released after that meeting contained sharp downward revisions to projections for GDP growth in 2012, with the committee's consensus view dropping to a range of 2.5 percent to 2.9 percent from the 3.3 percent to 3.7 percent increase officials had expected in June.

A new communications strategy could include an explicit inflation target, essentially a firming of the Fed's current "longer-run" consensus projection of 1.7 percent to 2 percent.

The central bank could also offer guidance as to where it would like to see the jobless rate go and specific forecasts for the overnight federal funds rate. It currently offers no interest rate projections.

Policymakers could even offer some idea of what they see as the expected size of the central bank's balance sheet over time, given the important role that bond purchases have played in the Fed's unconventional monetary policy push.

"We are considering that," said Plosser, a member of a Fed subgroup on communications. "In some cases unusual times call for unusual communications strategies."