The Federal Reserve signaled Wednesday that the weak economy likely will keep prices in check despite growing concerns that the trillions it’s pumping into the financial system will ignite inflation.
Fed Chairman Ben Bernanke and his colleagues held a key bank lending rate at a record low of between zero and 0.25 percent. And they pledged again to keep it there for “an extended period” to help brace the economy.
Fed policymakers also dropped language they had used in the statement at their last meeting in April that the weak economy could trigger deflation — a destabilizing and prolonged bout of falling prices and wages.
And they offered no new assurances that they would step up their purchases of government bonds and mortgage securities, to try to drive down rates on consumer debt. That rattled bond investors who fear the prospect of higher interest rates. So did the Fed’s observation that commodity prices are rising.
The mention of higher prices hit the Treasury market because the value of returns on fixed-income investments can erode quickly if inflation occurs. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3.69 percent from 3.63 percent Tuesday. Stocks also fell after the Fed’s announcement.
Still, the Fed said inflation will remain “subdued for some time.” And overall, Fed policymakers delivered a slightly more encouraging assessment of the economy.
“The Fed is sending the message that the economy is making progress toward a path of recovery, that the credit markets appear to be healing and inflation is not going to be a problem,” said economist Lynn Reaser, vice president of the National Association for Business Economics. “The bogeyman of deflation also was removed from the Fed’s primary risk list,” she added.
The Fed in March launched a $1.2 trillion effort to drive down interest rates to try to revive lending and get Americans to spend more freely again. It said it would spend up to $300 billion to buy long-term government bonds over six months and boost its purchases of mortgage securities. So far, the Fed has bought about $177.5 billion in Treasury bonds.
The Fed is on track to buy up to $1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year. Nearly $456 billion worth of those securities have been purchased.
With signs economic and financial conditions are stabilizing, the Fed is wise to keep a steady-as-she goes course, said Sung Won Sohn, economist at the Martin Smith School of Business at California State University, Channel Islands. The Fed’s actions are “bearing fruit,” he said.
Fed policymakers noted that the “pace of economic contraction is slowing” and that conditions in financial markets have “generally improved in recent months.” Those observations about the recession and financial conditions were stronger than after the Fed’s last meeting in April.
Economists predict the economy is sinking in the April-June quarter but not nearly as much as it had in the prior six months, which marked the worst performance in 50 years. The economy is contracting at a pace of between 1 and 3 percent, according to various projections.
Fed policymakers said its forceful actions, along with President Barack Obama’s stimulus of tax cuts and increased government spending will contribution to a “gradual “return to economic growth.
Bernanke has predicted the recession will end later this year. Some analysts say the economy will start growing again as soon as the July-September quarter.
Fed policymakers noted that consumer spending — the lifeblood of the economy — has shown signs of stabilizing but remains constrained by ongoing job losses, falling home values and hard-to-get credit.
Economists predict the Fed will hold its key banking rates at a record low through this year and into part of next year to spur lending and boost spending Americans. If so, that means commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay around 3.25 percent, the lowest in decades.
Even after the recession ends, the recovery is likely to be tepid, which will push unemployment higher.
The nation’s unemployment rate — now at 9.4 percent — is expected to keep climbing into 2010. Acknowledging that the jobless rate is going to climb over 10 percent, President Barack Obama said Tuesday he’s not satisfied with the progress his administration has made on the economy. He defended his recovery package but said the aid must get out faster.
Some analysts say the rate could rise as high as 11 percent by the next summer before it starts to decline. The highest rate since World War II was 10.8 percent at the end of 1982.
The weak economy has put a damper on inflation.
Consumer prices inched up 0.1 percent in May, but are down 1.3 percent over the last 12 months, the weakest annual showing since the 1950s. The Fed suggested companies won’t be in any position to jack up prices given cautious consumers, big production cuts at factories and the weak employment climate.
Full text of the Fed's statement:
Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.
The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.