Fed holds rates low as weak economy caps inflation4 min read . Updated: 17 Dec 2009, 11:07 AM IST
Fed holds rates low as weak economy caps inflation
Fed holds rates low as weak economy caps inflation
Washington: The US economy is growing, but only weakly. Layoffs have slowed, yet jobs remain scarce. And interest rates will need to rise — but not anytime soon.
That was the mixed picture sketched Wednesday by the Federal Reserve, which pledged to hold rates at a record low to reduce unemployment and sustain the recovery. And the assessment was reinforced by government data on inflation, home building and US trade.
Fed Chairman Ben Bernanke and his colleagues did sound a more optimistic note by pointing to the slowdown in job losses. But they made clear the recovery is far from strong: Consumer spending remains sluggish, the job market weak, wage growth slight and credit tight. Companies are still wary of hiring, they said.
In the meantime, the Fed isn’t wavering from its commitment to keep its bank lending rate at zero to 0.25 percent, where it has stood since last December. It said again it will keep rates there for an “extended period."
In response, commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will remain about 3.25%. That’s its lowest point in decades.
Super-low interest rates are good for borrowers who can get a loan and are willing to take on more debt. But those same low rates hurt savers. The rock-bottom rates are especially hard on people on fixed incomes who earn scant returns on savings accounts and certificates of deposit.
Michael Darda, chief economist at MKM Partners, predicted that rates would stay where they are for most of next year.
“We believe the Fed is essentially out of the picture until late 2010 or early 2011," Darda said. The Fed’s “optimism was constrained by a long list of caveats," he added.
Low inflation is one sign of the economy’s weakness. Companies are finding it hard to raise prices because consumers fearful for their jobs remain wary of spending much.
That was clear from a Labor Department report Wednesday on consumer prices. Prices did move higher last month. But that was mainly because of volatile energy costs.
After stripping out volatile energy and food prices, inflation disappeared last month. That gives the Fed leeway to hold its key interest rate at a record low to aid the recovery.
At the same time, home construction rebounded in November after a setback in October. And applications for new building permits _ a gauge of future activity _ rose more than economist had predicted. A housing recovery is vital to the overall economy.
Also, the government said its broadest measure of foreign trade posted a sharp increase in the July-September quarter, signaling higher demand for foreign goods. That, too, is seen as a sign of a slowly strengthening economy.
The current account is the broadest measure of trade because it includes not only trade in goods and services but also investment flows among countries.
For last month, the Consumer Price Index, the most closely watched inflation barometer, rose 0.4%. That was up from a 0.3% increase in October.
The government said energy prices rose 4.1%, reflecting more expensive fuel oil and gasoline. Energy prices, though, are already in retreat. Oil prices are down about 10% this month.
“Aside from the surge in energy prices ... there were few signs of any inflationary pressures," said Paul Ashworth, economist at Capital Economics Ltd.
The uptick in inflation last month, however slight, ate into Americans’ already-weak wages. Average weekly earnings, adjusted for inflation, dipped 0.7% from November 2008, according to a separate Labor Department report. It was the first such drop this year.
The Fed said it expects to wind down several emergency lending programs when they are set to expire next year. That seemed to strike a confident note that the Fed thinks it can gradually lift supports it provided at the height of the financial crisis.
The central bank made no major changes to a program, set to expire in March, to help further drive down mortgage rates.
The government is spending an unprecedented amount to prop up the housing market. The Fed expects to have bought $1.25 trillion in mortgage securities from Fannie Mae and Freddie Mac by the end of March. It’s bought $845 billion so far.
It’s also on pace to buy $175 billion in debt from those groups under the same deadline. So far, the Fed has bought nearly $156 billion.
Its efforts to lower mortgage rates are paying off. Rates on 30-year loans averaged 4.81%, Freddie Mac reported last week. That’s down from 5.47% last year.
The government has propped up the housing market in other ways, too. It’s spending roughly $15 billion for a tax credit for homebuyers. And that credit is being extended until spring at a cost of $8.5 billion. In addition, the cost of bailing out Fannie and Freddie could soar as high as $300 billion, according to Barclays Capital.
The Fed said it has leeway to hold rates at super-low levels because it expects that inflation will remain “subdued for some time."
Fed policymakers repeated their belief that slack in the economy — meaning plants operating below capacity and the job market staying weak — will keep inflation down.
Some worry that the Fed’s cheap-money policies will stoke inflation.
But Bernanke, who’s been named Time magazine’s “Person of the Year" for 2009, has sought to assure skeptical lawmakers and investors that when the time is right, he’s prepared to withdraw the extraordinary stimulus money the Fed has injected into the financial system. Doing so would reduce the likelihood of igniting inflation or new asset bubbles.
Some encouraging signs for the economy have emerged lately. The economy finally returned to growth in the third quarter, after four straight losing quarters. And all signs suggest it picked up speed in the current, final quarter of this year.