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Published: 6/25/2008

Federal Reserve leaves key rate unchanged at 2 percent

ASSOCIATED PRESS

WASHINGTON The Federal Reserve, navigating treacherous economic waters, decided on Wednesday to leave a key interest rate unchanged, bringing an end to a string of consecutive rate cuts.

The central bank announced that it was keeping the federal funds rate, the interest rate that banks charge each other, at 2 percent, marking the first time in 10 months that the central bank has failed to reduce interest rates at one of its regular meetings.

The Fed is confronted with the twin perils of a possible recession and rising inflation pressures, stemming from this year's surge in oil and food prices.

In a brief statement explaining the decision, Fed Chairman Ben Bernanke and his colleagues cited both the threats to growth and rising inflation pressures as problems confronting the economy at the moment.

The statement said that the downside risks to growth "appear to have dimished somewhat" while adding that "the upside risks to inflation and inflation expectations have increased.

The Fed action was approved on a 9-1 vote with Richard Fisher, president of the Fed's regional bank in Dallas, casting a dissenting vote. Fisher objected to the action, saying he would have preferred an immediate increase in interest rates to fight inflation.

The decision to leave rates unchanged had been widely expected by financial markets.

Because of the Fed's decision, short-term borrowing costs on millions of consumer and business loans tied to banks' prime lending rate will remain unchanged. The prime rate is currently at 5 percent, its lowest level since late 2004.

Investors are split about the Fed's actions for the rest of the year. Some analysts believe the Fed could start raising rates, possibly as soon as the next meeting in August because of concerns about inflation. Other economists argue that the weak economy and rising unemployment will keep the Fed on the sidelines until at least after the November elections.

While saying that the upside risks to inflation have increased, the central bank repeated its forecast that it expected "inflation to moderate later this year and next year."

The opposing forces of weak growth and recession put the central bank in a bind. Its main policy tool changes in interest rates can only address one of those problems at a time. The Fed can cut interest rates to spur consumer and business spending and economic growth or it can raise interest rates to slow spending and growth and ease inflation pressures.

From September through April, the Fed aggressively cut interest rates seven times. However, after a series of sizable rate cuts as the credit crisis was roiling global financial markets at the beginning of this year, the Fed at its last meeting in April reduced rates by a more modest quarter-point and signalled that the rate cuts could be coming to an end.

Even as Fed policymakers were meeting Tuesday and Wednesday, the economic news has continued to be bleak including a report showing that consumer confidence in June dropped to the lowest level in 16 years. Soaring gasoline prices, plunging home values and rising unemployment are all weighing on confidence.

The Bush administration is hoping that the government's $168 billion economic stimulus program, which is sending rebate payments to 130 million households, will help dissolve some of the gloom and bolster consumer spending in the months ahead.

Against the backdrop of economic weakness have been rising signs of inflation pressures stemming from crude oil prices which have shot up this year to above $130 per barrel, pushing gasoline prices to all-tme highs above $4 per gallon and also prompting other companies to boost their prices.

On Tuesday, Dow Chemical Co. announced it was raising prices on a wide range of products by as much as 25 percent, an increase that is coming on top of price hikes of up to 20 percent it announced on June 1.

In a speech on June 9, Bernanke took a tough line on inflation, saying that the Fed would "strongly resist an erosion of longer-term inflation expectations." Those comments and tough talk from other Fed officials unnerved investors who went from thinking the Fed might leave rates unchanged for most of this year to starting to worry that rate hikes could begin this summer.

Other analysts, however, said they believed Bernanke wanted to send out a strong anti-inflation warning, especially since it was coupled with a comment in an earlier speech about the Fed chief's concerns that the weak dollar was adding to U.S. inflation problems. The remarks taken together had the impact of bolstering the dollar, which had been tumbling.

Some economists saw the comments by Bernanke and his colleagues as an effort to convince the markets that the central bank is serious about fighting inflation without having to start raising interest rates at a time when the economy remains very weak.

The last thing the central bank wants is a repeat of the 1970s, when successive oil price shocks did trigger a wage-price spiral that sent inflation soaring and was only subdued when the Fed under Paul Volcker pushed interest rates to levels not seen since the Civil War.



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