FED FOCUS-Weak economy to prompt Fed QE3? Not so fast

Anemic U.S. growth is not enough to prompt Federal Reserve Chairman Ben Bernanke to call for a new round of monetary stimulus.

A failure to resolve the political deadlock over U.S. debt or a drop in inflation might be.

The economy grew at a bare 0.4 percent annual pace in the first quarter and a still disappointing 1.3 percent in the second, according to data released on Friday.

But Fed officials expect growth to pick up substantially this quarter, and are unlikely to consider a third round of quantitative easing, or QE3, unless that growth does not materialize, their comments suggest.

Even then, as Atlanta Federal Reserve Bank President Dennis Lockhart said on Friday, it's a "very high bar" for further stimulus. For details see [ID:nN1E76S0SJ].

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The biggest reason, Fed officials and economists say, is rising inflation.

In the 12 months to end-May, core inflation reached 1.2 percent, by the Fed's favorite measure. While that's not troubling on its face, it marks a sharp acceleration after bottoming out at 0.7 percent in the year to December.

Fed officials believe temporary factors account for some of that surge, but they are watching it closely as they aim to keep inflation over a mid-term horizon from topping 2 percent.

"Before going ahead they want to see clear evidence that the economy really is stuck and that inflation risk is contained," said Anil Kashyap, a professor at the University of Chicago's Booth School of Business.

So far, the evidence is not there.

"Inflation is elevated somewhat right now, so I think the backdrop for doing more stimulus, QE3 or whatever, is different," San Francisco Fed President John Williams said on Thursday.

In his prior job, as the regional Fed bank's research director, Williams was a vocal supporter of QE2, the central bank's second round of bond buying, which ended in June.

But those purchases were launched when officials were worried about deflation risks. With those risks largely banished, the equation has changed.

Officials are also concerned bond buying may generate diminishing returns in terms of its impact on the economy.