Video: Federal fund rate unchanged

updated 4/28/2010 5:15:26 PM ET 2010-04-28T21:15:26

The Federal Reserve sounded a more confident note Wednesday that the economy is strengthening but pledged to hold rates at record lows to make sure it gains traction.

Wrapping up a two-day meeting, the Fed in a 9-1 decision retained its pledge to hold rates at historic lows for an "extended period." Doing so will help energize the recovery.

The Fed offered a more upbeat view of the economy even as it noted that risks remain. It said the job market is "beginning to improve," an upgrade from its last meeting in mid-March. It observed then that the unemployment situation was merely "stabilizing."

The Fed also noted that consumer spending has "picked up," an improvement from its last observation that spending was expanding at a "moderate pace."

Even with the economic gains, the Fed noted reasons to be cautious. High unemployment, sluggish income gains and tight credit are still dampening consumer spending, a major contributor to economic activity. Commercial real estate remains fragile. And though housing activity has edged up, it is still at depressed levels. Bank lending continues to shrink.

The Fed's statement included nothing that would lead most economists to move up their forecasts for when the central bank will start raising rates. The soonest the Fed will do so is the fourth quarter, 34 of 44 leading economists polled told The Associated Press in a recent survey.

"The Fed did upgrade its assessment of the economy, but clearly there is too much headwind for the recovery" for the Fed to signal any plans to boost rates, said Sung Won Sohn, economist at California State University.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, for the third straight meeting was the sole member to dissent from the Fed's decision to retain the "extended period" pledge.

Hoenig has said he fears keeping rates too low for too long could lead to excessive risk-taking by investors, feeding new speculative bubbles in the prices of stocks, bonds and commodities.

He's also expressed concern that low rates could eventually unleash inflation. And Hoenig says he worries that keeping the "extended period" pledge will limit the Fed's stated "flexibility" to start modestly bumping up rates.

The Fed's brighter assessment helped give a modest lift to stocks. The Dow Jones industrials gained about 53 points, an increase of 0.48 percent. Prices for Treasurys slipped further after the Fed's statement. The yield on the 10-year note, which moves inversely to its price, edged up to 3.77 percent, from 3.75 percent just before the announcement.

Major Market Indices

The Fed has held its target range for its bank lending rate between zero and 0.25 percent, where it's remained since December 2008. In response, commercial banks' prime lending rate, used to peg rates on certain credit cards and consumer loans, has stayed about 3.25 percent. That's its lowest point in decades.

Record-low rates serve borrowers who qualify for loans and are willing to take on more debt. But they hurt savers. Low rates are especially hard on people living on fixed incomes who are earning scant returns on their savings.

Fed Chairman Ben Bernanke and his fellow colleagues said they have leeway to hold rates at record lows because inflation is likely to stay subdued because of "slack" in the economy.

Factories and other businesses are operating well below full throttle. Workers aren't likely to see hefty pay raises any time soon. And companies are wary of jacking up prices because consumers haven't shown signs of returning to their free-spending ways.

Once the economy is on firm footing, the Fed will need to start boosting rates to prevent inflation and bring policy closer to normal. Economists still think that is months away.

Mark Zandi, chief economist at Moody's Analytics, was among analysts who said they thought Greece's debt crisis is one reason why the Fed is proceeding with caution, even though it didn't mention the debt crisis in its statement.

Nonetheless, signals are growing that the U.S. economy has turned a corner. Employers added a net total of 162,000 job in March, the most in three years. Americans' confidence is rising, and they are spending more. Manufacturers are boosting production. And a rising number of companies — such as Ford, Caterpillar and UPS — are seeing their profits grow.

Given the economy's improvements, Chris Rupkey, economist at the Bank of Tokyo-Mitsubishi, expressed disappointment that the Fed didn't send a signal that higher rates are on the way.

"We think they should have lifted their foot off the gas pedal a little," he said.

A month ago, Rupkey thought the Fed would start boosting rates in June. But based on the Fed's renewed pledge Wednesday to keep rates at record lows for an "extended period," he now thinks August is the earliest it might happen.

The Fed provided no clues about when it will start shedding some of its vast portfolio of mortgage securities. Doing so would tighten credit by sopping up some of the unprecedented amount of money that was pumped into the economy during the financial crisis.

The Fed has bought $1.25 trillion of these securities to drive down mortgage rates and aid the housing market. Its challenge is to sell those assets in a way that doesn't weaken home prices and jack up mortgage rates. There's been disagreements within the Fed about the timing and method of such sales.

The Fed's balance sheet has exploded, reflecting the central bank's action to fight the financial crisis. It stood at $2.3 trillion for the recent week, more than double the level before the crisis struck.

In its statement, the Fed once again said the pace of the recovery will likely remain moderate. The Fed wants to see lower unemployment and consistent job growth before it considers a rate increase, analysts say.

The unemployment rate, now 9.7 percent, is expected to remain high. Neither economic growth nor job creation is expected to be robust enough to quickly drive the rate down.

"While I believe that the Fed will have to raise rates this year, unless the job market improves a lot more quickly than expected, that just may not happen," said economist Joel Naroff, president of Naroff Economics Advisors.  

Full text of the Fed's statement follows:

Information received since the Federal Open Market Committee met in March suggests that economic activity has continued to strengthen and that the labor market is beginning to improve. Growth in household spending has picked up recently but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures is declining and employers remain reluctant to add to payrolls. Housing starts have edged up but remain at a depressed level. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

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, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

In light of improved functioning of financial markets, the Federal Reserve has closed all but one of the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities; it closed on March 31 for loans backed by all other types of collateral.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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