Fed Leaves Interest Rate Unchanged

Sept. 16, 2008— -- The Federal Reserve unanimously decided this afternoon to leave a key interest rate unchanged despite renewed and deep fears about the health of the American financial system.

Since the central bankers last voted on interest rates in August, financial markets have deteriorated further and just yesterday the stock market had its worst single-day performance since the Sept. 11, 2001 terrorist attacks.

The Fed acknowledged all those concerns in its statement but still decided at this regularly scheduled meeting to keep the interest rate at 2 percent.

In its post-meeting statement, the Fed governors painted a bleak picture of the economy.

"Strains in financial markets have increased significantly and labor markets have weakened further," they said. "Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters."

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The committee also noted that inflation still remains high but expects it to moderate later this year and next year.

The stock market did not initially take the news well. The Dow Jones industrial average was up about 25 points right before the announcement but within 15 minutes was down 65 points. But just 15 minutes later, traders warmed up to the decision and the Dow was back in positive territory, up 25 points, and it ended the day up $141.51 points.

Economists were split before the meeting on whether the Fed would leave rates alone or make a cut. Most said that if a cut was to be made, it would have been a half a percentage point. Others said that no action today does not preclude the Fed from making an emergency cut before its next regularly scheduled rate meeting on Oct. 29.

The Federal Reserve has spent most of the past year aggressively cutting its key Fed Funds interest rate to stimulate an economy hammered by a collapsing housing market and the tightening of credit. Just a year ago, the rate stood at 5.25 percent.

Back after seven straight cuts, the Fed in June decided to leave rates at 2 percent. The main concern was quickly rising inflation, in part thanks to high oil prices. Others, however, said that despite the Fed's rate cuts, it wasn't doing enough to make new capital available – essentially no matter how cheap borrowing got banks were still hesitant to loan out cash.

After deciding again on Aug. 5 to leave rates steady, the Fed said, "Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain."

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Richard W. Fisher, president of the Federal Reserve Bank of Dallas was the lone vote in August against the committee's decision, instead favoring a rate increase. Since then, Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, has also signaled a willingness to raise rates to combat inflation.

But all of that was thrown out the window in the past few days.