Fed holds rates steady in the face of inflation
WASHINGTON -- The Federal Reserve on Wednesday voted to hold a key interest rate at 2%, ending nearly a year of sharp rate reductions designed to boost the faltering economy. In making no change, policymakers said the odds of an economic downturn had diminished while inflation risks have risen.
Central bank officials, concluding a two-day meeting, said in their statement they expect price pressures to ease through the end of this year and into 2009. But they pointedly warned that "uncertainty about the inflation outlook remains high" because of soaring energy costs and recent data showing consumers' inflation expectations are increasing.
The Fed's policymaking Open Market Committee didn't give a clear indication what its next move would be, saying it will monitor conditions and act as needed. Fed officials next meet Aug. 5.
Dallas Fed President Richard Fisher voted against the decision, saying he would have preferred to increase rates. Fisher in recent speeches has warned that the Fed must take a more aggressive stance against surging inflation.
"The Fed will be on hold for a prolonged period due to the economic weakness, but will raise rates early next year when growth picks up," says Kurt Karl, chief U.S. Economist for Swiss Re.
Previous Fed rate cuts, recent federal tax rebates and stronger exports because of the weaker U.S. dollar should boost economic activity by late 2008 year or early 2009, Karl says.
The Fed has reduced its target for the federal funds rate — what banks charge each other for overnight loans — to 2% from 5.25% in September. The rate ifnluences rates on many business and consumer loans.
The Fed statement noted that economic activity has expanded because of consumer spending. But it also said labor markets are under "considerable stress" and noted that spiking energy prices are hurting growth at the same time they are feeding inflation pressures.
"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation have increased," the Open Market Committee said.
The economy expanded at a 0.9% annual pace in the first quarter of the year, and economists expect somewhat higher growth when second-quarter figures are released. But government and private economic reports released in the past several days have been downbeat. Further, consumer inflation has been running at a 4.9% annual rate in the past three months.
Consumer confidence in June slumped to the lowest level in 16 years, according to the New York-based Conference Board. Demand for big-ticket durable goods like cars and refrigerators was flat in May, the government said Wednesday. Grain prices have soared since the Fed's last meeting in April, with major Midwest flooding hurting the corn crop.
U.S. automakers have announced sweeping incentive programs, including zero-interest financing and rebates, to jumpstart flagging sales. The manufacturing sector is faltering and housing is in a deep recession.
Under terms of stimulus legislation approved this year, the IRS has distributed 77 million checks worth $64 billion. Even though the federal income tax rebates have helped to buoy consumer spending, that may be just a temporary burst. Unemployment rose to 5.5% in May.
"We expect the Fed's next move to be a rate hike occurring sometime later in the year as the economy gains traction and returns to a definitive path of prosperity," said Rich Yamarone of Argus Research. "Currently, there is little in the tea leaves suggesting the economy has rejoined that path. This is the primary reason the Fed cannot raise rates now."