Fed holds rates steady, ending string of rises

By Glenn Somerville

WASHINGTON (Reuters) – The U.S. Federal Reserve on Tuesday
halted a more than two-year string of interest-rate rises,
holding its benchmark rate steady while it gauges whether a
slowing economy will keep inflation in check.

If not, the Fed indicated it will resume raising rates.

The central bank’s policy-setting Federal Open Market
Committee voted 9-1 to keep the federal funds rate target at
5.25 percent, pausing a cycle that had taken the rate steadily
higher in 17 successive hikes since mid-2004.

Richmond Fed Bank President Jeffrey Lacker dissented,
preferring a quarter percentage point increase but the Fed
provided no reason why Lacker voted as he did.

Stocks weakened as investors saw the Fed action confirming
a weakening economy. The Dow Jones industrial average lost
45.79 points to end at 11,173.59 while the high tech-laden
Nasdaq Composite Index dropped 11.65 to 2,060.85.

Prices for debt securities moved only modestly, since the
Fed decision was anticipated, and were mixed. The 30-year U.S.
Treasury bond shed 8/32 in price and yielded 5.02 percent while
the bellwether 10-year Treasury note was unchanged.

Recent economic indicators have pointed to a downshift in
the economy, led by a cooling housing market, but wages and
prices continue to rise, and the Fed made clear its optimism
about inflation was wary and conditional.

“Inflation pressures seem likely to moderate over time,
reflecting contained inflation expectations and the cumulative
effects of monetary policy actions and other factors
restraining aggregate demand,” the Fed said in a statement
after the meeting.

STILL SEE RISKS

“Nonetheless, the committee judges that some inflation
risks remain,” the central bank added, saying any further rate
moves would depend on the outlook for prices and growth.

While the Fed action offered some drama, it did not
surprise markets. Policy makers did not signal they were
calling off the rate-rise campaign, only that they were
preserving their ammunition for use if needed.

“They did pretty much what was expected by leaving rates
unchanged, but more importantly if you look at the statement
they are certainly leaving the door open to the possibility of
further hikes if needed,” said economist Rick Egelton of BMO
Financial group in Toronto.

A Reuters poll on Tuesday underlined the doubt about the
Fed’s future course. Thirteen out of 23 primary dealers — the
biggest Wall Street firms — said they thought the Fed was done
raising rates and some thought rate cuts were possible by early
2007.

Only four of the 23 dealers expect a rate rise from the
next FOMC meeting, scheduled for September 20.

As the Fed meeting began, the government reported that
growth in productivity, or hourly output per worker, slowed to
a 1.1 percent annual rate in the second quarter of this year
from 4.3 percent in the first quarter.

After its previous meeting on June 29, the Fed cited steady
productivity gains as having helped curb inflation
expectations, a conclusion that may come into question after
the softer second-quarter productivity performance.

This time, there was no reference to productivity and some
analysts predicted its weakening pace was one reason the Fed
will be obliged to raise rates again later this year.

“I’m a bit surprised to see the Fed saying inflation was
moderating while we are having signs, including today’s
productivity numbers, that inflation is not decelerating,” said
economist Tim Rogers of Briefing.com in Boston, adding he
expected rate rises to resume later this year.

Soaring gasoline costs and oil prices that topped $77 a
barrel earlier this week are causing anxiety among consumers.

RATE PINCH COMING

In recent speeches, Fed officials have cited softening data
and stressed the full impact of prior increases in overnight
interest rates had yet to be felt.

They have also expressed hope that slowing growth might
dampen upward price pressures.

In the second quarter, the economy grew at an annual clip
of 2.5 percent, much slower than the brisk 5.6 percent pace in
the first three months of the year.

And last week, the government’s employment report showed
only 113,000 jobs were created in July, down from 124,000 in
June and below the first quarter’s monthly average 176,000.

In addition, the previously soaring housing sector has lost
altitude as would-be buyers face stiffer financing costs and
builders reduce groundbreaking in response to weakening sales.

But consumer prices have kept rising.

The Fed’s preferred inflation gauge, the core personal
consumption expenditures price index, which excludes food and
energy, rose 2.4 percent in the year through June — well ahead
of the pace perceived to be the Fed’s comfort zone.