By Alister Bull
WASHINGTON (Reuters) - The Federal Reserve may have to wait until early next year before it sees sufficient strength in the U.S. economy to begin scaling back its bond-buying stimulus, after a destructive Washington budget battle that may take a bite out of growth.
Complicating the Fed's task, a 16-day government shutdown choked off the flow of much of the economic data on which it relies and could undermine the quality of the reports covering October.
Lawmakers voted on Wednesday to end the shutdown and lift the U.S. debt limit, averting a potential default that many economists had warned could tip the United States back into another severe recession.
The deal clears the way for the release of delayed updates on the health of the economy, including data on employment, retail sales and factory output for September.
But the shutdown will probably hurt the quality of some other indicators covering activity this month that rely on surveys which were not conducted because government staff were furloughed. That will mean readings on the state of activity in October will be unusually suspect.
On top of this, the harm potentially done to U.S. growth by the wrangling in Washington could encourage policymakers to wait a little longer to monitor whether the softness in hiring that worried them in September was only temporary.
Economists polled by Reuters since the October 1 shutdown found the median estimate of the drag on fourth-quarter U.S. growth was 0.3 percent annualized. They now see growth in the quarter at just a 2.3 percent annual rate, which might not be enough to lower the jobless rate further.
OCTOBER OFF THE TABLE
Analysts said there were a number of factors the Fed would need to consider in deciding when to pare its $85 billion in monthly purchases of Treasuries and mortgage bonds.
"October is out of the running. December is not an impossible scenario but seems increasingly unlikely. I think the debate is revolving around January versus March," said Eric Lascelles, chief economist with RBC Global Asset Management in Toronto, referring to the Fed's upcoming policy meetings.
"Each has its charms, and each has its challenges."
Lawmakers agreed to fund the government until January 15, and raise the debt ceiling until February 7, which means the fiscal fight could start all over again in the New Year.
That would argue for making a move as soon as December, before fiscal clouds gather, or waiting until March, by which time they should have cleared.
By March, the economy's fundamental strength should be easier to discern, absent another confidence-shaking political standoff or government shutdown.
"If they were going to be consistent, they would not have an opportunity to go until March. That would be the first chance for a clean look" at the economy, said Michael Feroli, an economist with JPMorgan in New York.
If the Fed does not move in December, there is another factor that may lead it to wait until March. Fed Chairman Ben Bernanke steps down at the end of January and is replaced by Fed No. 2 Janet Yellen, presuming the Senate confirms her. Making a major policy shift on the eve of the handover does not look like ideal timing. The Fed meets on January 28-29.
However, if it skips January and waits until March, the Fed would add another $255 billion to its balance sheet - a figure that would likely cause a fair amount of discomfort on the central bank's policy panel unless the economy was in clear need of support.
Minutes of the Fed's meeting in September, when it surprised markets by delaying an announcement to slow its bond-buying pace, showed a number of the central bank's 19 policymakers viewed the decision as a close call.
DECEMBER NOT IMPOSSIBLE
For those reasons, officials might be looking at December, provided that the broad picture they see is of an economy that has rebounded confidently from the drag of the fiscal showdown.
The possibility of tough budget negotiations in the New Year would likely not be enough to prevent action, partly because the Fed will not want to tie monetary policy to an increasingly unpredictable Congress.
"If risky asset markets are doing well in December, if the employment figures are looking stronger, if the unemployment rate moves lower, a taper is on the table at that meeting," said Dean Maki, chief U.S. economist at Barclays in New York.
Bernanke said in June the Fed expected to begin the process of ending the massive asset purchase program later this year.
The key question is whether the economy will show enough strength by December to make a move.
"The Fed is probably going to be looking at employment conditions that are not that different from where they were in September," said Carl Tannenbaum, chief economist with Northern Trust in Chicago. That doesn't remove December from the taper-table, but it would be a tough decision, he said.
(Reporting by Alister Bull; Editing by Andrea Ricci)