By Greg Robb, MarketWatch
A previous version was corrected to fix the size of the Federal Reserve’s balance sheet.
WASHINGTON (MarketWatch) — The Federal Reserve on Wednesday took another unconventional step to boost the economy, and Fed Chairman Ben Bernanke said the central bank stood ready to take more action if needed.
In the statement following its two-day meeting, the Fed said it would extend its holdings of long-term government bonds by $267 billion in another effort to bring down borrowing costs.
The Fed, which is selling an equal amount of short-term securities to hold steady the size of its $2.9 trillion balance sheet, is extending the “Operation Twist”? program that was due to end in June through the end of the year.
• Live blog and video of the Fed decision and press conference
• First Take: Janet Yellen’s no more confident than the rest of us
Bernanke told reporters at his press conference that he was watching the labor market closely.
“We still do have considerable scope to do more and we are prepared to do more,” Bernanke said. “If we’re not seeing sustained improvement in the labor market that would require additional action.”
Keeping “Operation Twist” in place “should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative,” according to the central bank.
Recent economic data have been disappointing. At the moment, economists are forecasting a 2% growth rate in the second quarter. This would be the fourth quarter out of five where growth was at or below 2% — too slow a pace of growth to make a dent in the high unemployment rate.
In a statement, the Fed said that consumer spending has slowed, adding that it expected economic growth to pick up “very gradually.” “Consequently, the Fed anticipates that the unemployment rate will decline only slowly,” the statement said. The Fed’s now forecasting an unemployment rate between 8% and 8.2% this year — basically, no improvement from June’s level of 8.2%.
The Fed also noted that housing remained depressed. “Strains in global financial markets continue to pose significant downside risks to the economic outlook.”
“The Fed is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions,” the Fed said in what amounts to adopting an easing bias.
U.S. stocks initially declined, before see-sawing higher about an hour after the move took place, and then declined once more. Unrelated comments from German Chancellor Angela Merkel may have more to do with the gains then the Fed’s action.
The Dow Jones Industrial Average (DOW:DJIA) closed Tuesday at a five-week high, which indicates markets had priced in a good part of the Fed’s action already.
Eric Green, global head of rates research and strategy at TD Securities, said the statement “was more dovish than expected.”
“I read the Fed as saying: ‘One more jobs report and we’ll do more,’ ” added Justin Wolfers, an economics professor at the University of Pennsylvania, in a tweet.
Only one of the 12 voting members voted against the action at the end of the two-day meeting of the Fed’s interest-rate setting body, the Federal Open Market Committee.
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Richmond Fed President Jeffrey Lacker cast the lone dissent, a consistent position at all four meetings this year.
In his discussion of the economy, Bernanke said the European debt crisis is slowing the U.S. economy.
But the Fed will stick to playing a consulting role with the region’s leaders.
“There is a lot of work to be done” in the euro zone, he noted.
The housing market and weak state and local governments are also dampening growth.
Bernanke said that a lack of credit was a major issue for the economy.
He said that the Fed was very interested in a U.K. plan, dubbed funding for lending, where the Bank of England would offer British banks access to cheap loans as long as they agree to lend it to companies and households.
Many economists had expected the action. They said it was, in part, a signal to markets that the central bank is prepared to do whatever it takes to spur demand. Several economists had speculated the Fed would also purchase mortgaged-backed securities as part of the Twist.
A few were surprised.
Mike Moran, chief economist at Daiwa Securities America, said he thought the Fed would hold steady, awaiting for more clarity about whether the recent slowdown in the economy was a payback for a warm winter.
Moran said he thought the Fed finally decided to move in order not to “frustrate or confuse the market” that had come to expect the central bank would extend the Twist program.
Some analysts doubt whether the move will do much to spur the economy.
Ethan Harris, co-head of global economic research at Bank of America, recently described Twist as “like shooting a squirt gun at the economy.”
The Fed will ultimately launch another large-scale asset purchase program, or quantitative easing, to help support the economy, Harris said.
Fiscal policy, which many analysts say would be more effective in helping the slumping economy, is widely seen as frozen until after the November presidential election. Then lawmakers will have to quickly make deals to avoid a “fiscal cliff” of planned tax hikes and spending cuts that could throw the economy back into a recession.
In its statement, the Fed announced that it will leave its target range for its federal funds rate unchanged at 0% to 0.25%, where it has been since December 2008.
Central bankers also made no changes to the guidance that they expect to keep rates steady until late 2014.
The Fed said it would continue to reinvest the proceeds of maturing agency debt and mortgage-backed securities into mortgage-related debt.
Harvard economics professor Martin Feldstein said recently that the Fed’s Operation Twist has helped the bond market and the stock market, but has had little impact on economic activity.
Since the Twist plan was first announced late last September, the 10-year note yield has fallen to 1.65% from 2% and residential mortgage rates have fallen to 3.71% from 4.09%. But other factors, especially a flight to safe U.S. assets as the European debt crisis intensified, have played a part in bringing down bond yields, analysts said.
Over the same eight months, the Dow industrials have jumped 15.4%.