Fed expected to retain interest rate peg
Washington, October 25:
After engineering the longest unbroken stretch of interest rate increases on record, the Federal Reserve may now keep rates unchanged for an extended period.
At least that is the view of many economists who think the Fed may leave rates alone for up to a year, preferring to remain on the sidelines and allow a slowing economy to lower inflation pressures.
That, however, isn’t necessarily the view of financial markets, which have been whipsawed between worries that the Fed will keep raising rates and periods of euphoria that the central bank might start cutting rates later this year.
Federal Reserve Chairman Ben Bernanke and his colleagues began a two-day meeting on Tuesday that will wrap up Wednesday with an announcement on rates. “The Fed is in a holding pattern that is going to last a lot longer than the markets are expecting,” said David Jones, chief economist at DMJ Advisors, an economic consulting firm.
Jones predicted rates would remain unchanged until the second half of next year when he forecast two rate cuts.
After raising rates at 17 consecutive meetings over two years, the Fed in August paused and also left rates unchanged at the September meeting.
The federal funds rate, the interest that banks charge each other, is currently at 5.25 per cent.
If the Fed keeps rates unchanged for a third meeting, it would mean a break for borrowers. It also would be good news for the Bush administration, which would rather not see voters upset by rising interest rates two weeks before polls to decide whether Republicans will retain control of Congress.
Commercial banks’ prime lending rate, which responds to changes in the funds rate, is currently at 8.25 per cent, where it has been since Fed’s last rate hike. The prime had been at 4 per cent, the lowest level since 1958, when the Fed began its rate increases in 2004.
The Fed’s rate increases are having the desired effect of slowing interest-sensitive portions of the economy such as housing, with sales and construction of new homes tumbling this year, contributing to a sharp slowdown in overall growth.
Many economists believe growth may have dipped to around 2 per cent in the July-September quarter, even weaker than the 2.6 per cent rate of the spring. The pronounced slowdown had raised concerns about a possible recession, prompting financial markets to rally on the belief that the Fed would soon cut rates to avert that possibility.
However, comments by various Fed officials in recent weeks have signaled that the central bank believes recent declines in energy costs will help bolster consumer spending and avert a recession. At the same time, Bernanke and his colleagues have continued to indicate their concerns that inflation remains too high.