Fed sees sharp US budget cuts as 'sizeable risk'

The Federal Reserve sees a quick, sharp tightening of US spending as a "sizeable risk" to the economy, minutes from a recent top-level policy meeting revealed on Wednesday. Several members of the Fed's interest rate-setting panel have expressed fears that uncertainty about dramatic budget cuts could curb business hiring and economic growth. At the end of this year, if Congress does not act, automatic budget cuts will hack $1.2 billion off government spending at the same time that billions of dollars' worth of tax cuts expire. Taken together, the measures aim to trim an estimated $6.8 trillion off the US deficit over a decade. But they would also force a sudden contraction in government spending, crucial to the economy. "If agreement is not reached on a plan for the federal budget, a sharp fiscal tightening could occur at the start of 2013," the minutes noted. "Uncertainty about the trajectory of future fiscal policy could lead businesses to defer hiring and investment." While Fed officials have previously spoken about the looming fiscal cliff, the minutes of the Federal Open Market Committee's April 24-25 meeting show the depth of that concern. "It is clear from the minutes that some Fed officials have started to worry about the implications of the 'fiscal cliff,'" said Stephen Stanley, an economist with Pierpont Securities. In April, Fed Chairman Ben Bernanke warned Congress that the central bank would not be able to act as a saviour for the economy if Congress failed to act. "The size of the fiscal cliff is such that there is, I think, absolutely no chance that the Federal Reserve could or would have the ability whatsoever to offset that effect on the economy," he said. Yet the subject remains highly contentious in Washington, which is mired in partisan sniping as the country rushes toward presidential elections in November. The Republican speaker of the House of Representatives, John Boehner, has indicated he wants a showdown with President Barack Obama over the issue. Last year the failure of America's political parties to reach a deal over budget issues resulted in a first-ever downgrade of the country's credit rating. Meanwhile the Fed also warned that the incessant debt crisis in Europe could yet hit the United States. "Strains in global financial markets stemming from the sovereign debt and banking situation in Europe continued to pose significant downside risks to economic activity both here and abroad," the minutes noted. The minutes also showed some support for further stimulus if the US recovery slows sharply. "The economy continued to expand moderately," participants noted. "Labor market conditions improved in recent months." But most analysts saw the Fed standing pat. "The committee, on balance, saw the incoming data as improving enough to alter its forecast in favor of stronger growth, lower unemployment, and higher inflation, but did not feel confident enough about the improvement to adjust its policy stance," said Michael Gapen of Barclays Capital. There was also some skepticism that recent strong economic data could be the start of a rapid improvement in the world's largest economy. Some members of the committee "thought it was premature to infer a stronger underlying trend from the recent positive indicators, since those readings may partially reflect the effects of the mild winter weather or other temporary influences."