Fed keeps rate near zero, tries to ease fears on inflation
WASHINGTON -- Citing a "weak" but improving economy, the Federal Reserve left interest rates unchanged Wednesday and took no further steps to pump cash into stagnant credit channels, moderately disappointing stock and bond markets.
The central bank and its colleagues voted unanimously to keep a key interest rate near zero and reiterated plans to purchase up to $1.75 billion in government debt and securities. However, some economists had expected the policymakers to expand the size or timing of the securities purchases, a strategy that tends to drive down interest rates and mortgage rates, and spur equities markets.
The Dow Jones industrial average fell 23.05 to close at 8299.86 after rising as much as 100 points earlier in trading. Bonds and Treasury prices also dipped and yields rose on expectations that inflation eventually could force the Fed to raise rates.
"Conditions in financial markets have generally improved in recent months," the Federal Open Market Committee said in a statement after its two-day meeting. "Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth and tight credit."
The Fed cuts interest rates to lower borrowing costs and spark the economy, and raises rates to head off inflation.
In its statement, the central bank made clear it's still not worried about rising costs, saying "inflation will remain subdued for some time." It added that the "pace of economic contraction is slowing."
After its April meeting, the policymakers voiced some concern about excessively low inflation or deflation that could further stanch economic growth. That was omitted from Wednesday's release.
"It suggests they might be somewhat more willing" to raise interest rates eventually, though likely not within the next year, says UBS economist James O'Sullivan.
Conrad DeQuadros, an economist with RDQ Economics, thought the Fed at least might extend the timing of its securities purchases, which are a less conventional way of driving down interest rates. Earlier this year, the Fed said that by year's end it will purchase up to $1.25 trillion in mortgage-backed securities issued by Fannie Mae and Freddie Mac, an additional $200 billion of their debt and $300 billion of Treasury notes.
"I think they're trying to achieve some sort of balance" between economic growth and concerns about eventual inflation, DeQuadros says.
Some went further. Greg Salvaggio, senior vice president for capital markets at Tempus Consulting, believes the Fed is subtly setting the stage for a plan to unwind its securities purchases and perhaps even raise interest rates by year's end.
Economists are worried the massive U.S. deficit, created largely by the Wall Street bailout and economic stimulus package, could spark inflation and increase borrowing costs. That has pushed up rates for long-term Treasuries and mortgages.
Separately, the Commerce Department reported Wednesday that orders for durable goods rose a better-than-expected 1.8% in May, further fueling expectations that the economy could start a recovery by year's end. It marked the third increase in the past four months and far surpassed analysts' estimates of a 0.8% decline in orders.
Orders for core non-defense capital goods rose 4.8%, while those for machinery jumped 7.7% and computers and electronic parts, 2.2%. But motor vehicle orders fell 8.1%.
Federal Reserve Chairman Ben Bernanke has predicted the recession will end later this year. Some analysts say the economy will start growing again as soon as the July-September quarter.
Even after the recession ends, the recovery is likely to be tepid, which will push unemployment higher.
The nation's unemployment rate — now at 9.4% — is expected to keep climbing into 2010. Acknowledging that the jobless rate is going to climb over 10%, President Obama said Tuesday he's not satisfied with the progress his administration has made on the economy. He defended his recovery package but said the aid must get out faster.
Some analysts say the rate could rise as high as 11% by the next summer before it starts to decline. The highest rate since World War II was 10.8% at the end of 1982.
The weak economy has put a damper on inflation.
Consumer prices inched up 0.1% in May, but are down 1.3% over the last 12 months, the weakest annual showing since the 1950s. The Fed suggested companies won't be in any position to jack up prices given cautious consumers, big production cuts at factories and the weak employment climate.
Contributing: Associated Press