Fed Holds Rates Steady, Issues Inflation Warning
Federal Reserve policymakers decided Tuesday to keep short-term interest rates at 6.5% for a third month running, saying the nation’s economic growth is beginning to slow to a more sustainable pace.
Although the Fed included a stern warning about the risk of resurgent inflation, policymakers suggested they think they are finally getting a handle on the danger of higher prices. That’s a change from earlier this year when officials said the economy seemed to be shrugging off Fed-engineered rate hikes and continuing to boom beyond its limits.
In a statement explaining its decision, the Federal Open Market Committee said recent economic statistics indicate that “expansion of aggregate demand is moderating toward a pace closer to the rate of growth of the economy’s potential to produce.”
The central bank’s policy-making body also said that improvements in productivity, or output per worker, are raising the economy’s “potential growth rate as well as containing costs and holding down underlying price pressures.”
The Fed decision, which was expected, leaves the federal funds rate--the rate at which commercial banks make short-term loans to each other--at its highest level in nine years. Since June of last year, the Fed has raised the rate six times by a total of 1.75 percentage points. Those moves have driven up the cost of borrowing for everything from cars to capital equipment.
Tuesday’s decision was widely interpreted as signaling that, absent unexpected change, the Fed will sit out the rest of the presidential election campaign and perhaps the remainder of the year. “They’re on standby until January,” said Sung Won Sohn, chief economist of Wells Fargo & Co.
Investors greeted Tuesday’s action tepidly. The Dow Jones industrial average rose 59.34 points, or 0.5%, to 11,139.15 and the tech-heavy Nasdaq composite index inched up 5.06 points, or 0.1%, to 3,958.21. But the Standard & Poor 500 index, which measures the broader market, slipped 1.35 points, or 0.1%, to 1,498.13.
Bond prices barely budged during the day. But they have risen substantially since mid-July when Fed chairman Alan Greenspan told Congress he saw signs the economy was slowing. The rise has sent the yield or market interest rate on a 10-year Treasury note down 40 basis points, a sign that traders believe inflation will not eat away at their investments.
The Fed decision followed a string of reports showing the first substantial signs of economic slowdown in several years. Among them: a drop in new job creation, steady but modest wage growth and a slowing in sales of houses, appliances and cars.
But the economy’s 5.2% annual growth rate from April through June, as well as the continuing climb in energy prices and a revival in retail sales during July, left economists and policymakers uncertain about whether the slowdown is permanent or just temporary.
“The evidence is murky, which is just about what you’d expect when you are trying to bring the economy in for a soft landing,” said William Cheney, chief economist with John Hancock Financial Services in Boston.
That murkiness was behind the Fed’s warning Tuesday that the economic “risks continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future.” The warning signaled that the central bank is maintaining its “tightening bias,” or tilting toward raising, rather than lowering, rates if it takes any further action at all.
Even with the warning, however, the Fed’s statement explaining its decision appeared to be distinctly more optimistic than its other recent pronouncements. For example, the central bank said outright Tuesday that growth “is moderating,” while in its June 28 statement it said only that growth “may be moderating” and that signs of slowdown were “tentative and preliminary.”
That change of tone has some economists convinced that the central bank is finished raising interest rates and ready to declare victory in its efforts to orchestrate an economic soft landing. “This tightening cycle is done,” predicted Brian S. Wesbury, chief economist with the Chicago investment bank of Griffin, Kubik, Stephens & Thompson.
But others said that further rate hikes are likely. Allen Sinai, chief global economist with Primark Decision Economics in Boston, said the open market committee will not act at its Oct. 3 meeting, its only remaining session before the election. But he added that it could raise rates a quarter of a point at its Nov. 15 meeting.
“The message is clear: The Fed thinks we’re headed in the right direction,” Sinai said. “We’re just not there yet.”
