The Fed eases its stance on rates

The Federal Reserve on Wednesday suggested it had softened its disposition toward raising interest rates, boosting hopes for rate cuts this year that could spur growth and ease housing woes.

While leaving its benchmark short-term rate unchanged at 5.25% as expected, the Fed referred to “future policy adjustments” without specifying possible rate increases as it has done in the past. That indicated the central bank had adopted a more neutral stance -- and was not leaning toward raising rates as much as before, analysts said.

Investors hoping for rate cuts were cheered. The Dow Jones industrial average, flat prior to the announcement, rallied sharply on the news, posting a gain of nearly 160 points -- its biggest of the year.

The Fed also acknowledged that the economy and housing market were slowing, saying recent economic indicators “have been mixed and the adjustment in the housing sector is ongoing.” But the Fed also said it was more worried about inflation than slowing growth, saying its “predominant policy concern remains the risk that inflation will fail to moderate as expected.” That suggested more rate hikes might be in store.

The Fed’s inclusion of statements that were both dovish and hawkish toward inflation suggest the central bank wants to be more flexible, facing an economy that is both slowing and showing signs of rising inflation, analysts said. Gasoline prices have risen sharply recently while consumer and wholesale inflation came in higher than expected last month.

“They are opening the door [to rate cuts] if the numbers continue to be weak on the growth front,” said Andrew Tilton, senior U.S. economist at Goldman Sachs in New York, who predicted the Fed would cut rates at its June meeting after inflation had cooled.

The Fed has left interest rates unchanged at its last six meetings, after raising rates 17 times since 2004. Consumer prices have been rising at an annual rate of 2.4%, above the Fed’s comfort zone of between 1% and 2%.

Given the Fed’s inflation-fighting tendencies, Fed Chairman Ben S. Bernanke will have to resist the urge to raise interest rates as growth slows, analysts said.

“The economy is dancing along the precipice of recession and inflation remains stubbornly high,” University of Maryland economist Peter Morici said. In the short-term, he said, “the Federal Reserve cannot do much. Cutting interest rates to boost growth would accelerate inflation. Raising rates to slow inflation would be futile.”

Many analysts expect U.S. economic growth to slow to as little as 2.3% this year from 3.3% last year because of the housing slump and slower consumer spending.

“The Fed continues to gallantly fight inflation. The problem is nobody in the market is the least concerned about inflation. Everybody in the market is concerned about housing,” said T.J. Marta, an economic strategist at RBC Capital Markets in New York, who predicted the Fed would cut interest rates twice before the end of the year.

Stocks’ big gains Wednesday pushed several major indexes into positive territory for the year. The Dow Jones industrial average rocketed 159.42 points, or 1.3%, to 12,447.52. The blue-chip indicator is down only fractionally this year after falling almost 6% from its high in late February to its low this month.

The Standard & Poor’s 500-stock index rose 1.7% and the Nasdaq composite climbed 2%. The gains pushed both indexes into the black for the year.

Wednesday’s rally fed a growing perception on Wall Street that the latest market decline, which began with a 416-point plunge in the Dow industrials on Feb. 27, had run its course.

“The bull market continues,” said Charles Blood, director of strategy research at Brown Brothers Harriman in New York. “I don’t think it’s blowout time, but it’s back to the uptrend.”

Yet disappointing housing numbers this week, combined with slower consumer spending, have some economists raising the odds of a recession. Housing starts were down 28.5% in February compared with a year earlier, the Commerce Department said Tuesday. Building permits to start construction on single-family homes fell in February for the 12th time in 13 months, as construction dipped to its lowest level in nine years.

More sub-prime mortgage lenders closed their doors or announced layoffs in recent weeks amid increasing defaults on mortgages. On Wednesday, San Francisco-based Wells Fargo & Co. announced plans to eliminate more than 500 jobs in its sub-prime loan division.

With lenders and regulators restricting some sub-prime loans, the Fed will be watching mortgage markets for signs of a broader credit crunch that could sharply slow economic growth and trigger a recession, said Brian Bethune, U.S. economist at Global Insight in Lexington, Mass.

“The Fed still has its foot on the brake pedal and that could cause the economy to slow even further than it already has. That’s what they’re concerned about,” Bethune said.

“What they don’t want to do is be in a position where they’d be stampeded into rate cuts” because of a credit crunch, he said.

Former Fed Chairman Alan Greenspan, citing sub-prime mortgage failures, last week put the odds of a recession this year at 1 in 3. University of Maryland economist Morici put the odds even higher, at 40%.

But Morici said the Fed probably would steer the economy through the housing crisis by holding interest rates steady.

“We’ll probably be OK. If you don’t have a cataclysmic event or a policy misstep, you can avoid a recession,” Morici said.

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molly.hennessy-fiske@ latimes.com

Times staff writer Walter Hamilton in New York contributed to this report.

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Fed’s statement

Here is the Federal Reserve’s statement on interest rates Wednesday:

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

Recent indicators have been mixed, and the adjustment in the housing sector is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters.

Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures.

In these circumstances, the committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.