June 26, 2008

Fed Ends String of Interest Rate Cuts

By Sue Kirchhoff

WASHINGTON -- Saying that inflation risks are increasing and recession threats are easing, the Federal Reserve on Wednesday voted to hold a key interest rate at 2%. The move ended a months-long campaign of sharp rate reductions to boost the faltering economy.

Central bank officials, concluding a two-day meeting, said in a statement that they expect price pressures to ease through the end of this year and into 2009. But they pointedly warned that "uncertainty about the inflation outlook remains high" because of energy costs and consumers' increasing inflation expectations.

The Fed's policymaking Open Market Committee didn't give a clear indication what its next move would be, saying it will monitor conditions and act as needed. Fed officials next meet Aug. 5.

Dallas Fed President Richard Fisher voted against the decision, preferring a rate increase to combat inflation.

"The Fed will be on hold for a prolonged period due to the economic weakness, but will raise rates early next year when growth picks up," says Kurt Karl, an economist at reinsurer Swiss Re.

The Fed, in a series of cuts, has reduced its target for the federal funds rate -- what banks charge each other for overnight loans -- to 2% from 5.25% in September. The federal funds rate influences rates on many business and consumer loans.

The Fed statement noted that economic activity has expanded as consumer spending firmed a bit. But it also said the job market has weakened, financial markets are under "considerable stress" and rising energy prices are hurting growth as they feed inflation.

"Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation have increased," the Fed said.

The economy expanded at a 0.9% annual pace in the first quarter of the year, skirting a recession. But some economists said they were not as optimistic as the Fed on growth, warning the economy could slow later in the year as the impact of $64 billion in one-time federal tax rebate checks wears off.

"The Fed has a difficult period of decision-making ahead of it, as the inflation risk issue clearly points in the direction of higher rates, but the growth outlook for the end of 2008 and 2009 now has 'recession' printed on it," says Brian Bethune of Global Insight.

Consumer inflation has run at a 4.9% annual rate in the past three months, propelled by oil prices near $135 a barrel. At the same time, consumer confidence in June slumped to the lowest level in 16 years, according to the New York-based Conference Board. Demand for big-ticket durable goods such as cars and refrigerators was flat in May, the government said Wednesday. Grain prices have soared since the Fed's last meeting in April, as Midwest flooding hurt the corn crop. The housing sector is mired in a deep recession.