``Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments,'' according to minutes of the Aug. 5 Federal Open Market Committee meeting released in Washington.
The minutes today show a debate over the magnitude of the inflation threat, with two groups of officials making different judgments on the impact of the recent slide in commodity prices. Policy makers also diverged on whether financial turmoil continues to pose the risk of a more severe credit crunch.
The Fed left its benchmark lending rate unchanged at 2 percent for the second straight meeting on Aug. 5. At the time, traders estimated a 31 percent chance of at least a quarter- point increase by the end of the year, futures prices show. Now, that probability is 22 percent.
Today's release also showed that Philadelphia Fed President Charles Plosser opposed creating a new program offering investment banks options on borrowing Treasuries from the central bank.
``Many participants noted that the financial system remained fragile, with some expressing continued concern about the possibility of an adverse feedback loop'' where tighter credit conditions push the housing market even lower, the minutes said. ``Several other participants suggested that the risks to the financial system had receded.''
With market instability triggering a rise in borrowing costs for households and businesses, ``most members did not see the current stance of policy as particularly accommodative,'' the minutes said.
Chairman Ben S. Bernanke said the Fed ``is committed to achieving medium-term price stability and will act as necessary to obtain that objective'' in his remarks opening the Jackson Hole, Wyoming, monetary conference on Aug. 22.
``A number of participants worried about the possibility that core inflation might fail to moderate next year unless the stance of monetary policy was tightened sooner than currently anticipated by financial markets,'' the minutes said.
With the economy faltering, U.S. central bankers are trying to reconcile both aspects of their dual mandate to limit inflation while sustaining economic growth that maximizes employment.
The Fed staff ``marked down'' its forecast for gross domestic product growth for the second half of 2008 and for 2009, the minutes said. Prices, minus food and energy, were ``expected to pick up somewhat in the second half of the year.''
The consumer price index rose 5.6 percent for the 12 months ending in July. The Fed's preferred benchmark, the 12-month change in the personal consumption expenditures price index, minus food and energy, has been at 2 percent or higher since March 2004. Adjusted for the core PCE rate, the real federal funds rate is slightly below zero, the lowest since November 2004.
``Inflation has not been coming down and this language about expecting inflation to moderate has been in the statement for two years now and it hasn't happened,'' said William Poole, former president of the St. Louis Fed. ``But it hasn't gotten enough worse to swing the central part of the committee to act.''
``Heightened investor apprehension about the viability of Fannie Mae and Freddie Mac had eased following legislative action, but pressures on these firms continued,'' the minutes said.
The U.S. Treasury now has authority to provide any necessary financial support for the firms, making access to Fed loans less urgent. Still, shares of the mortgage finance companies are lower as investors conclude that government involvement would come at a cost to equity investors.
Housing markets remain weak. Some 4.67 million houses and condos were on sale in July, according to the National Association of Realtors. The 11.2 months supply, measured by the current sales pace, matches a prior record.<...