Fed holds interest rates near zero

By Reuters
Posted June 23, 2010 at 1:23 p.m.

The Federal Reserve acknowledged a faltering pace of U.S. economic recovery on Wednesday as it renewed its vow to hold benchmark interest rates exceptionally low for an extended period.

In a statement at the end of a two-day meeting, the Fed scaled back its assessment of the pace of recovery, taking note of pockets of weakness, and issued a cautionary note about volatile financial markets in light of Europe’s debt woes. But it stuck to its expectation that the economy will continue to gradually emerge from the worst recession in decades.

“Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad,” the central bank said in a statement.

As expected, the Fed held overnight rates in the zero to 0.25 percent range set in December 2008 as the central bank fought the deep recession and virulent financial crisis.

Kansas City Federal Reserve Bank President Thomas Hoenig dissented for the fourth meeting in a row, arguing the Fed’s promise to hold rates ultra low for a long time risks perpetuating a boom-and-bust cycle.

The Fed said the recovery was “proceeding,” a downgrade from its assessment in April when it said the economy had continued to strengthen.

The Fed also nodded to a recent softening of inflation. It noted that energy and other commodity prices had declined in recent months, and underlying inflation had trended lower.

Recent disappointing jobs and housing reports, financial turmoil in Europe and a four-decade low in a key inflation metric have raised doubts about the outlook, prompting some analysts to push back forecasts for Fed rate hikes.

While most economists think a rate increase will be the next step, some have suggested the Fed should consider additional ways to spur growth and lending.

A report Wednesday showing new single-family home sales plunged to a record low in May after a popular homebuyer tax credit expired dealt a clear setback to hopes for a speedy pickup in growth.

Fed Chairman Ben Bernanke told a congressional panel this month that he believes the economy has made the shift to private demand after a period of government-provided life support.

Still, he cautioned that “a significant amount of time” would be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009.

The Fed’s anecdotal summary of economic conditions compiled for this week’s meeting found that while conditions were still improving, the pace of growth was modest.

Some Fed officials have said in recent weeks they see growth gaining momentum. Kansas City’s Hoenig has argued the recovery is strong enough, and the risks of inflation from the Fed’s easy money policies are serious enough, that raising rates to 1 percent fairly soon is warranted.

Bernanke said he expects the world’s largest economy to expand at a 3 percent annualized rate this year and gain steam in 2011.

Most economists expect the Fed to begin pushing up borrowing costs next year, but the recent string of downbeat economic data has some contemplating a further easing of monetary policy.

The economy added jobs in May, but the lion’s share were public sector positions. In addition, mortgage applications have plummeted since the homebuyer tax credit expired at the end of April. Like sales of new homes, sales of previously owned homes also slumped last month.

Financial turmoil in Europe on doubts about euro zone member countries’ ability to meet debt obligations has roiled financial markets, pushing up interbank lending rates and sparking fears of a renewed credit crunch.

In the United States, bank lending has continued to contract, as banks tighten lending standards and problem commercial property loans on their books crimp their ability to provide fresh credit.

Against that backdrop, consumer prices excluding food and energy rose a scant 0.9 percent through May. Officials would like to see year-on-year core inflation between 1.5 percent and 2 percent.

Excessively low inflation could be a problem, as consumers put off spending in hopes prices will fall more and businesses cut prices to lure them back, setting off a dangerous deflationary spiral.

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