Fed weighing inflation risk

Issue is key as end of stimulus nears

By Jeannine Aversa
Associated Press / April 26, 2011

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WASHINGTON — The Federal Reserve, increasingly confident in the economy, is about to end a $600 billion program to support it. Now for the next step: figuring out how to keep inflation from taking off.

Since late last year, the Fed has bought government bonds to keep interest rates low. Chairman Ben Bernanke and his colleagues are expected to signal this week that they will allow the program to expire in June, as scheduled. That would end almost all extraordinary measures the government took to prop up the economy, aside from tax cuts.

Worries that the economy would fall back into recession have all but disappeared. The private sector is adding jobs, and the stock market is at its highest point since the summer of 2008.

But higher oil and food prices pose a threat. If companies are forced to raise prices quickly to make up for escalating costs, that could start a spiral of inflation. How much of a threat inflation poses is a matter of disagreement at the central bank. A minority say the Fed may need to raise interest rates by the end of this year to fight inflation. The Fed has kept its benchmark rate near zero since December 2008.

Richard Fisher, president of the Federal Reserve Bank of Dallas, argues the Fed should consider halting the bond program now, not in June. “Now we at the Fed are nearing a tipping point,’’ Fisher said earlier this month, referring to inflation. The majority, including Bernanke, say the bond-buying program should run its course.

Bernanke has predicted the jump in oil and food prices will cause only a brief, modest increase in consumer inflation. Excluding those prices, which tend to fluctuate sharply, inflation is still low, he has argued.

Bill Gross, who manages the world’s largest mutual fund at Pimco, worries that rates on Treasury bonds will rise when the Fed stops buying them. If other buyers don’t step in and there’s less demand for Treasury bonds, then the rates, or yields, on those bonds would rise. That would drive down prices on bonds. Rates on mortgages, corporate debt, and other loans pegged to the Treasury securities would rise, too. Higher borrowing costs could slow the economy.

Fed officials say that because the end of the program has been publicized, it won’t have much of an effect on bond rates.