Fed officials amplify concerns over Europe

CHICAGO (Reuters) - Three Federal Reserve policymakers amplified their concerns over Europe's crisis on Monday, offering some praise for the weekend deal to bail out Spanish banks but warning that much is yet to be done to avoid global spillovers.

The euro zone's simmering financial and debt crisis is front and center as the Fed meets next week to decide whether it needs to take yet more policy action to insulate the weak economic recovery from slowing even more.

The European Union deal struck over the weekend to bail out debt-stricken Spanish banks "is good news and it alleviates slightly some of the concerns. Nonetheless there are many issues that Europeans are going to face," Atlanta Federal Reserve Bank President Dennis Lockhart said at a conference in Chicago.

"Markets are looking for the details of how much will be injected into what banks, whether that will be sufficient to stabilize those particular banks ... and what the terms and conditions are," he told reporters.

The EU agreed to a bailout of up to 100 billion euros for Spain's banks. But Spanish and Italian bond yields jumped on Monday as doubts set in about the impact and terms of the deal, which was designed to avoid a run on Spanish banks.

On June 17, Greece holds elections that could cause it to exit the euro zone - yet another possible source of vulnerability for the world's interconnected financial markets.

The Fed, frustrated by a faltering U.S. recovery, is keenly interested in European events.

The U.S. central bank has taken unprecedented steps, including the purchase of more than $2 trillion in long-term securities to battle the deep 2007-09 recession. Yet U.S. growth has been erratic and unemployment remains high at 8.2 percent.

"The European sovereign debt crisis threatens banks in that continent, and, by extension, elsewhere," said John Williams, president of the San Francisco Federal Reserve. "Clearly, it represents a significant threat to financial stability," he said at a separate conference sponsored by his regional Fed bank.

The Fed's policy committee meets on June 19-20 and many economists think it could act to shore up the economy.

Pressure has intensified on the Fed to take yet more policy action after U.S. job growth in May was far weaker than expected and as the European crisis worsened in the last couple of weeks.

"The European situation is one that we're monitoring very closely, and it does give one pause about what it means for the U.S. economy and the global economy," Charles Evans, head of the Chicago Fed bank, said later on Monday.

Both Lockhart, a moderate, and the more dovish Williams vote this year at Fed policy meetings, while Evans does not.

FLIGHT TO TREASURIES

Last week, Chairman Ben Bernanke said the Fed was ready to act to protect the U.S. economy if the European crisis deepens, but he offered few hints that more policy stimulus was imminent.

If it chooses to act, the Fed can buy more long-term bonds or mortgage-backed securities, or extend the co-called Operation Twist program that expires this month, in which it sells shorter-term bonds and buys longer-term ones in an effort to keep borrowing rates low.

The central bank can also adjust the date on a conditional pledge it has made to keep interest rates near zero until at least late 2014.

Lockhart said he was not convinced that current economic circumstances call for additional monetary easing "quite yet."

"I don't think any of the options should be taken off the table under the current circumstances. But I'm not convinced at this moment that the circumstances quite yet call for additional action," he told reporters.

U.S. Treasuries have benefited as investors have sought safe-haven debt outside of the euro zone, with has sent benchmark U.S. debt yields in recent weeks to record lows. Benchmark 10-year Treasury notes were last yielding 1.60 percent, about 16 basis points above the historic low set on June 1.

"It remains to be seen whether that picture holds, therefore it remains to be seen whether we might need further action to sustain that level of attractive interest rates for borrowers," Lockhart said of the ultra low yields.

"It does in some respects take the pressure off, to do something about financial conditions per se," he added.

Evans has long called on the Fed to clarify what economic conditions would prompt it to ultimately tighten policy. Such a move, he said, would help stabilize yields "at an appropriately low level, which might actually be higher than where we are currently given all the safe haven flows."

Last week, the European Central Bank decided not to lower interest rates. Asked about a possible coordinated rate cut, as many of the world's central banks did in October 2008, Lockhart only noted that there is a precedent.

"It's an appropriate response under unusual circumstances," he said, "not necessarily an every day mode of operation."

(Additional reporting by Timothy Ahmann; Editing by Neil Stempleman and Dan Grebler. Desking by Christopher Wilson)

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