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Fed holds policy steady, sees recession easing

Fed holds policy steady, sees recession easing
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First Published: Thu, Jun 25 2009. 09 33 AM IST
Updated: Thu, Jun 25 2009. 09 33 AM IST
Washington: The Federal Reserve on Wednesday stuck to its huge program of buying government and mortgage debt, which is designed to keep borrowing costs low and boost recovery, and said it saw signs that the deep US recession was easing.
The US central bank kept interest rates near zero percent and signaled less concern on deflation, which is considered a threat to the economy because a pattern of falling prices causes consumers and businesses to delay purchases, dragging the economy down further.
It also said inflation would “remain subdued for some time” and provided no hint on an imminent exit from bold policy easing, despite fears among investors the huge US stimulus could stoke price increases.
“Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing,” the Fed said in its policy statement at the end of a two-day meeting. “Conditions in financial markets have generally improved in recent months.”
The Fed said it decided to hold overnight interest rates in a zero to 0.25% range - the level reached in December - and repeated that rates would likely stay unusually low for some time.
But the Fed cautioned that the economy would remain weak for a time, and the Dow Jones industrial average fell on the news. Economists said the Fed’s outlook means rates will be on hold until well into 2010.
“The Fed is highly likely to hold short rates at rock-bottom levels until the volume of economic ‘slack´ ... is substantially lessened, which means short rates are unlikely to rise any time soon,” Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut, wrote in a client note.
The dollar extended gains against the euro and the yen while prices on US government debt fell in disappointment that the Fed did not increase its purchases of longer-dated Treasuries.
Nine out of the 15 primary dealers polled by Reuters said the Fed will raise interest rates in 2010, and six said the central bank will wait until 2011 before hiking rates.
Quantitative easing
With the benchmark interbank lending rate virtually at zero, the Fed has focused on driving down other borrowing costs by buying mortgage-related debt and US government bonds.
In its statement, the Fed said it would hold to a previous pledge to buy $1.45 trillion in mortgage-related securities and $300 billion in longer-term government debt.
The central bank dropped a phrase it had used in its April statement in which it warned inflation could run below desired levels for a time - a suggestion that officials were worried about the risk of a troubling downward spiral in prices.
It also did away with a sentence in the April statement that referenced various emergency liquidity programs devised by the Fed during the crisis to stop credit markets freezing.
“The statement wisely avoiding confusing the market with exit strategy discussions but may have signaled a slight backing away from extraordinary support by dropping reference to the ‘range of liquidity programs´,” Michael Feroli, an economist with JP Morgan Chase, said in a note to clients.
While sounding more comfortable about deflation risks on Wednesday, policy-makers stressed that inflation was not yet a concern.
“The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the committee expects that inflation will remain subdued for some time,” the Fed said.
Holding steady
With little change in the statement to chew over, economists focused on the Fed’s continued caution.
“Most importantly, despite the signs of some modest improvement in current conditions, the (Fed) continues to indicate that economic activity is likely to remain weak for a time,” said Morgan Stanley economist David Greenlaw.
The Fed had cut rates to near zero at the end of last year as part of a campaign to counter turmoil in financial markets and pull the economy out of a recession that began in late 2007.
Even with the overnight rates as low as they can go, the US central bank has found ways to lower other borrowing costs. In March, it more than doubled its planned purchases of mortgage-related securities and announced a plan to buy Treasury debt to drive down benchmark yields.
At first, the initiative to buy government bonds pulled down longer-term rates, a boon to mortgage borrowers. But this month yields on longer-term Treasuries climbed sharply as investors began to fret that the massive US budget deficit and generous Fed lending could sow the seeds of future inflation, although yields have since retreated.
Economic reports since the Fed’s previous meeting on 28-29 April suggest the downturn in the economy, the deepest in decades, is starting to abate. In perhaps the most hopeful sign, US job cuts moderated in May, although the unemployment rate hit a nearly 26-year high of 9.4%.
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First Published: Thu, Jun 25 2009. 09 33 AM IST
More Topics: US | Fed | Stocks | Recession | Jobs |