Fed holds steady but is wary of inflation

The Federal Reserve left its benchmark short-term interest rate unchanged Wednesday at 5.25% but said economic growth was expected to pick up -- leaving open the possibility of new rate hikes.

Echoing its two previous post-meeting statements, the Fed’s policymaking Federal Open Market Committee acknowledged that “inflation pressures seem likely to moderate over time” because of lower oil prices and previous rate boosts.

Although some inflation risks remain, “Going forward, the economy seems likely to expand at a moderate pace,” the Fed said.

Thanks to renewed consumer confidence, the economy could speed up enough by early next year to prompt another Fed rate hike, many economists say.

Such a rebound depends partly on business owners like Jay Underwood and their customers.

Underwood, 42, saw traffic slow this year at his Atlas men’s clothing store in Walnut Creek, Calif., as gasoline prices rose. After pump prices began to fall last month, customers returned to buy jeans and boots that sell for $90 to $100.

“They all came out in droves again,” Underwood said, adding that he expected to expand his staff of seven in coming months, hiring two to four permanent employees.

“People seem to be pretty optimistic about the economy in general,” he said.

Such renewed consumer optimism stems not only from falling gas prices and less-threatening inflation but also from low unemployment, robust hiring, a rebounding stock market and a national housing slowdown less severe than expected.

That could give new life to an economy that has been slowing. Many analysts expect the government to report Friday that third-quarter growth slowed to 2.1%, the lowest rate since the Gulf Coast hurricanes last year and down from 2.6% in the second quarter.

No rate hikes are expected soon. Fed Chairman Ben S. Bernanke has vowed to fight inflation, which is still too high for the Fed’s comfort. Core consumer prices, excluding food and energy, were up 2.9% in September compared with the same month a year ago and up 3.4% for the year, still well above the Fed’s comfort zone.

Many analysts expect the Fed to hold its key short-term interest rate at 5.25% until the middle of next year, waiting for the delayed effects of its 17 straight rate hikes that began in June 2004. The goal is to bring the economy to a comfortable 3% growth rate, with inflation of 1% to 2%.

“They’re sort of immunized against bad near-term news on growth or inflation,” said Jan Hatzius, an economist at Goldman, Sachs & Co. in New York.

He said the Fed expected previous rate hikes to continue to curb inflation without slowing growth enough to push the economy into recession. But, Hatzius said, “we have to wait until next spring to see if those assumptions pan out.”

Some analysts say inflation fears are easing. Consumer prices fell 0.5% last month, the biggest drop in 10 months, as retail gasoline prices declined. The nation’s average cost at the pump has fallen to $2.208 a gallon, the Energy Department reported Monday, down from $3 during the summer.

As prices fall, consumers’ paychecks are growing. As of September, inflation-adjusted average weekly earnings were up 2.2% for the year, noted Bernard Baumohl, executive director of Economic Outlook Group, a Princeton Junction, N.J.-based forecasting firm.

Analysts are waiting to see whether higher consumer confidence translates into more sales at cash registers.

“The key thing to watch going forward is retail sales,” said Drew Matus, senior economist at Lehman Bros. in New York. “Retail sales will tell us how the consumer feels more than any consumer confidence survey, and it will tell us how much money they have to spend better than any economist.”

Retail sales, excluding gas, were up 0.6% last month, driven by clothing and department store sales.

But holiday sales are expected to grow slightly less than last year, up 3% for November and December compared with 3.6% last year, said Michael Niemira, chief economist at the International Council of Shopping Centers.

Brodie Stewart might typify the more cautious consumer. He was browsing the racks this week at Atlas, the Walnut Creek clothing store. Stewart, 28, a singer and songwriter, just started a record label with a friend for about $50,000 and said he considered the economy “fair.”

“As far as spending is concerned, I don’t think I would do anything crazy at this point,” he said, but “I’m always looking for something as far as clothing is concerned.”

Even if consumers shop less, analysts predict that businesses will continue to spend, keeping the economy afloat.

Others are skeptical that growth will pick up next year. Hatzius, the Goldman Sachs analyst, said slow job creation could produce slower growth of 2% to 2.5% next year, leading the Fed to cut rates.

Reasa Pabst, 46, says an interest rate cut by the Fed would help her commercial printing business and the housing market in Jacksonville Beach, Fla., where new condominiums that once sold in a day sit vacant, she said. Her A1A Surfside Printing shop has suffered a sales slowdown that also has driven two competitors out of business this year.

But she is still spending. Four months ago, Pabst bought a new, higher-profile shop and hired two employees. She would like to buy some new equipment too, but she is watching interest rates, worrying about whether her investment will pay off.

“People are just being a lot more cautious,” she said.

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molly.hennessy-fiske@latimes.com

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Text of Fed statement on rates

Here is the statement about interest rates issued Wednesday by the Federal Reserve:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5.25%.

Economic growth has slowed over the course of the year, partly reflecting a cooling of the housing market. Going forward, the economy seems likely to expand at a moderate pace.

Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures.

However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Nonetheless, the committee judges that some inflation risks remain.

The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.