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With economic risks 'evolving,' Fed policymakers assess what's next

FILE PHOTO: The Federal Reserve building is pictured in Washington, DC

By Ann Saphir and Jonnelle Marte

CHICAGO/NEW YORK (Reuters) - U.S. central bankers see "evolving" risks to the world's biggest economy from the fast-spreading coronavirus and are scrambling to assess what's next, both for the business outlook and the Federal Reserve's own response.

This week the Fed delivered a surprise half-percentage point rate cut - bringing the target rate to a range of 1.00% to 1.25% - after cases of the disease that emerged in China exploded in South Korea, Italy and elsewhere, and global stock prices swooned on fears of a pandemic.

Since then, cases of COVID-19, the sometimes fatal respiratory illness caused by the virus, have continued to rise, with people testing positive in more U.S. states.

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Companies are increasingly responding by having employees work from home, reduce travel, and take other steps to curb the virus' spread, though such measures also could slow economic activity.

"Should the number of U.S. cases increase significantly, containment measures (and fear) could dampen domestic activity as travellers, shoppers, and employees avoid contagion risks," the San Francisco Fed said in its quarterly report on banking conditions in the Western U.S.

"The depth and breadth of impact remains uncertain given the evolving nature of containment."

With less than two weeks before the Fed's next policy-setting meeting, financial markets are pricing in more rate cuts ahead.

"Our policy action this week positions us well to support the economic expansion," New York Fed President John Williams said on Thursday, noting that before the virus made itself felt the U.S. economy had "very good momentum" powered by solid jobs growth.

"We are carefully monitoring the effects of the coronavirus on the U.S. economic outlook and will respond as appropriate," he said, adding that Fed officials are coordinating with central banks around the world to reduce the risks to the global economy and ensure that financial markets are running smoothly.

Speaking in Chicago, Dallas Fed President Robert Kaplan said that a key factor in shaping his view of whether more policy easing will be needed is the number of new cases of the disease in coming days, rather than backward-looking data such as the monthly jobs report due from the Labor Department Friday.

As for whether the Fed will ease policy further on March 17-18, Kaplan said he "wouldn’t presume what the Fed is going to do from here...I want to take it one day at a time..."

But in the end, Kaplan said he hopes the disruption to the U.S. economy will last only a quarter or a bit more, and that the rate cut this week will help the economy recover faster.

"We’ll have some slowing, and I hope in hindsight it will turn out to be transitory," Kaplan said.

INSURANCE

Also speaking on Thursday was Minneapolis Federal Reserve President Neel Kashkari, who said the Fed could cut rates further if needed.

"This was insurance that we took out because nobody knows how bad the virus is going to be," he said, noting companies react to uncertainty by pulling back on activity. If in a few months the impact of the virus has passed, he said, the Fed could raise rates again.

For now, central bankers are doing what they can to keep financial markets running smoothly. Kaplan said that one option the Fed has is encouraging banks to go easy on borrowers affected by the virus who are otherwise creditworthy.

New York Fed President Williams said the U.S. central bank will make sure that there is an ample supply of reserves in the banking system.

The New York Fed has been intervening in money markets since mid-September, when a shortage of cash led to a spike in short-term borrowing rates.

The Fed is also purchasing $60 billion (£46 billion) a month in short-term Treasury bills in an effort to increase the level of reserves in the banking system.

Policymakers have discussed scaling back the repo operations and the bill purchases in the second quarter, but some analysts wonder if the Fed will need to delay those plans because of the uncertainty caused by the coronavirus.

(Reporting by Jonnelle Marte; Editing by Leslie Adler)