CHICAGO/NEW YORK (Reuters) - The Federal Reserve has moved closer to embarking on a new round of its controversial money-pumping after the central bank and its chairman Ben Bernanke highlighted a grim outlook for the U.S. economy.
Bernanke on Wednesday opened the door a bit wider for the Fed to return to buying securities in the months ahead to buttress a weak recovery and keep inflation from slipping too far below its newly adopted 2-percent target.
"It sounds like the finger is on the trigger," said Thomas Simons, a money market economist at Jefferies & Co.
The Fed's announcement that it was unlikely to raise interest rates until at least late 2014, more than a year beyond its previous guidance, immediately pushed down Treasury bond yields and Bernanke's comments to the media raised expectations of a further round of so-called quantitative easing, or QE3.
It remains to be seen if the potential political backlash proves too daunting.
The prospect of the Fed pumping yet more money into the U.S. economy was seized upon by Republican hopeful Newt Gingrich to slam President Barack Obama's record. That highlighted the political pitfalls for the Fed in an election year.
Barring an unexpected pick-up in inflation or the U.S. economy suddenly kicking into a higher gear, Bernanke said it was logical that the Fed should look at ways to do more to help.
"The framework makes very clear that we need to be thinking about ways to provide further stimulus if we don't get improvement in the pace of recovery and a normalization of inflation," he told a quarterly news conference.
"Probably the main take-away from the press conference is the sense conveyed by Bernanke that it would not take much of a disappointment in growth or inflation to get the Fed to start another round of QE," said Michael Feroli, chief U.S. economist at J.P. Morgan.
"In fact, from his answers it's not even clear any disappointment would be necessary to see more QE," Feroli wrote in a note, adding he was not forecasting another round of asset purchases even if the bar for action was low.
The Fed in late 2008 slashed interest rates to near zero and has since bought $2.3 trillion in long-term securities in an unprecedented drive to spur growth and revive the economy after the worst recession in decades.
Yet the recovery has been slow and the outlook issued by the Fed on Wednesday was bleak.
With core inflation now at 1.7 percent and Fed officials forecasting unemployment to stay above 8 percent this year, many analysts took Bernanke's comments to mean QE3 is all but inevitable.
Economic, rate projections link.reuters.com/zud36s
News conference after FOMC: link.reuters.com/xud36s
The Fed has trained its sights on the stalled housing market in recent months, so any move to QE3 is most widely expected to involve buying mortgage securities to help bring down further already record-low mortgage interest rates.
Some economists said Bernanke may wait until the end in June of the Fed's "Operation Twist", which involves selling short-term bonds and buying longer-term ones in its $2.9 trillion portfolio to push down long-term interest rates further.
Bernanke may also want to wait until the market has absorbed his sweeping changes in communications policy which included the Fed adopting an explicit inflation target and releasing the interest rate projections of its policymakers for the first time on Wednesday.
Buying more mortgage-backed securities would drive down longer-term rates on mortgages with a view to countering what remains a drag on a U.S. economy still struggling to emerge from the worst recession in generations.
"I think it could happen any time now, based on the language that we saw today," said Eric Stein, a portfolio manager at Eaton Vance in Boston.
"I would think the first thing would be squarely focused on purchasing mortgage-backed securities, partially because Treasury yields are already so low, and housing is one of the major issues."
The blowback from a heavy round of MBS purchases could be just as fierce as that provoked by the Fed's second round of quantitative easing which was announced in November 2010.
QE2, which targeted Treasuries, attracted sharp criticism from Republicans who warned it could fuel inflation and crimp the Fed's ability to tighten policy eventually, and who accused Bernanke of going beyond the central bank's mandate.
"People are now expecting more QE, and that would be in mortgages," said John Canally, investment strategist and economist at LPL Financial in Boston. "I think economically they (the Fed) would want to do that, but I don't know if politically they can withstand the forces against it."
Republican presidential candidates have repeatedly criticized the Fed and Bernanke on the campaign trail. Asked about the Fed's latest statement, Gingrich said it was "a sign of the failure of the entire Obama program" that Bernanke is bracing for such weak economic growth that he will have to keep rates low for so much longer.
At the same time the Fed is "putting in future inflation expectations," Gingrich told reporters in Florida on Wednesday. "It's more of Bernanke laying down a very bad future."
Foreign countries slammed the Fed's previous bond-buying programs, saying they artificially weakened the U.S. dollar and hurt their exporters. Brazil's finance minister talked of a "currency war."
Some economists say the political pressure on the Fed may prove too heavy.
"A third round of QE is still beyond them - or maybe the chairman simply doesn't have the stomach for the congressional mauling that further asset purchases would have precipitated....," said Ian Shepherdson, chief U.S. economist at High Frequency Economics.
Nonetheless, many others expect that the Fed will act again.
Economists at 12 of 18 primary dealers, the large financial institutions that do business directly with the Fed, believe the central bank will undertake further quantitative easing, according to a Reuters poll after Bernanke's news conference.
Some top investors have placed their bets, too.
Bill Gross, who runs the world's largest bond fund, has ramped up purchases of mortgage-backed securities which at the end of November accounted for 43 percent of his holdings. The self-styled "bond king" said last month that any QE3 would likely be focused on the housing sector.
Keith Wirtz, chief investment officer at Fifth Third Asset Management, with $18 billion in assets, said the Fed had gone "all in" with its promise to keep rates low through late 2014, and predicted that any rise in long-term borrowing costs would push the Fed to buy more bonds.
"Brace for QE3 if rates start to move higher on the long end," he said.
Reporting by Ann Saphir and Jonathan Spicer; Additional reporting by Jennifer Ablan, Sam Youngman, Rodrigo Campos and Karen Brettell; Editing by Kim Coghill