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Federal Reserve leaders face encouraging yet unnerving picture ahead of meeting

By Neil Irwin and Dina ElBoghdady
Washington Post Staff Writers
Thursday, January 20, 2011; 8:11 PM

As the Federal Reserve gears up for its first policy meeting of 2011, its leaders face the challenge of making sense of an economic picture that is encouraging - including upbeat reports Thursday on housing and unemployment - yet still unnerving.

Private economists are generally expecting U.S. economic growth to accelerate a bit in 2011, perhaps to 3.5 percent or so from a pace last year below 3 percent. At their meeting Tuesday and Wednesday, Fed officials will present their own forecasts, which will be made public in mid-February, and discuss the prospects for growth in 2011.

The Fed is almost certain to maintain the policy it announced late last year of trying to encourage growth by buying about $75 billion in Treasury bonds each month through June. Those purchases would ultimately expand the Fed's holdings by $600 billion.

"In the near term, the policy decision is easy - they'll just keep things on track," said Julia Coronado, chief U.S. economist at BNP Paribas. "They have a lot more to do in laying out their views, tone and outlook for the economy that will be presented to the public. They want to acknowledge some of the promising signs but not give some sense that they're getting ahead of themselves."

The latest readings Thursday seem to show the economy is gradually healing. The number of people filing new claims for unemployment insurance benefits fell to 404,000 last week, the Labor Department said, the second-lowest level since 2008. That figure suggests that a spike in such claims in the first week of January was an aberration.

And sales of previously owned homes jumped 12 percent in December over November, showing some signs of life in the moribund housing sector.

Fed leaders are pleased - and even a bit relieved - that growth seems to have accelerated beyond the roughly 2.5 percent pace at which job creation is just enough to keep up with population and productivity growth, and at which the unemployment rate, as a result, would remain stuck at its high level. In particular, they view the chances of a new recession as much lower than a couple of months ago.

"We see the economy strengthening," Federal Reserve Chairman Ben S. Bernanke said in a panel discussion last week. "It's looked better in the last few months. And we think that 3 to 4 percent type of growth number for 2011 seems reasonable."

The Fed's bond purchase program, its signature initiative to try to help the economy get on track, was controversial both inside and outside the Fed when it was announced Nov. 3. At the first Federal Open Market Committee meeting of 2011, two of the most frequent detractors of the program within the Fed, Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser, will gain votes on the panel as a result of its rotating membership.

One open question is whether Fisher and Plosser, who have often articulated reservations in private and public, will dissent from the expected decision allowing the program to proceed.

"It could be that they decide to vote to stick with the current package, acknowledging that they didn't like it but that they'll go ahead and show solidarity now that it's underway," Coronado said.

Despite some signs of economic progress, there remain plenty of reasons for worry. Job growth remained soft in December, according to Labor Department data released at the start of January.

"The net read on the economy," said Steven Ricchiuto, chief economist at Mizuho Securities, "is that the recovery continues but the labor market remains stuck in first gear."

Fed officials have discussed three major risks facing the economy, according to minutes of their December meeting: budget cutbacks by state and local governments, further weakness in the housing market and spillover from the European debt crisis.

Despite the uptick in December existing-home sales reported Thursday, home purchases in 2010 were the lowest in 13 years, according to the National Association of Realtors.

Last year's sales dropped 4.8 percent to an annual pace of 4.9 million homes, the association said. That's slightly lower than it was in the housing market's darkest days in 2008.

Low interest rates, relatively affordable prices and tentative optimism about the economy helped lure buyers in December. But the biggest drag on the housing market remains the nation's high unemployment rate and the bloated supply of homes for sale, including foreclosed properties at low prices.

The supply of existing homes available for sale shrank by 4.2 percent in December to 3.56 million homes. It would take 8.1 months to sell these homes at the current pace. While that's down from November's 9.5-month supply, the inventory is still well above the five-to-six-month range considered healthy by real estate experts.

Mark Vitner, a senior economist at Wells Fargo Securities, said he expects prices to keep dropping through the first half of the year.

"The story revolves around foreclosures," Vitner said. "Until the inventory clears, builders are remaining on the sidelines" and prices will remain sluggish.

This week, the federal government reported that builders broke ground on fewer houses in December, when housing starts fell 4.3 percent to the lowest level since October 2009.

Sales were down 4.5 percent in the Washington region in December from a year ago, but the median price rose to $329,500 from $310,200.

irwinn@washpost.com dina@washpost.com

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