Fed stands by rock-bottom interest rates for near future

By Neil Irwin
Washington Post Staff Writer
Thursday, November 5, 2009

Federal Reserve leaders are sticking with their policy of very low interest rates for some time to come, they indicated Wednesday, but gave new details of the factors they will use to decide when to change course.

Fed policymakers, following a two-day meeting, said that "economic activity has continued to pick up." But they also said that conditions are "likely to remain weak for a time," and left their target interest rate at a range of zero to 0.25 percent, as was widely expected. They also said that low rates are likely to be warranted "for an extended period."

Fed leaders were signaling that they view the economy as sufficiently weak, and the recovery sufficiently fragile, that they are in no hurry to raise rates. The zero-interest-rate policy, put in place 11 months ago, has been a significant factor in the nascent economic turnaround, helping to lower borrowing costs for consumers and businesses and to replenish depleted bank balance sheets.

"Basically, they're saying they're not going to do anything for quite a while," said Kurt Karl, chief U.S. economist for Swiss Re. "They're saying that things are getting a little bit better in the economy, but it's nothing to get exuberant about or to cause an inflation problem."

But the central bank did provide some specifics about the conditions driving the low-interest-rate policy: An economy that is producing well below its potential and inflation that is both low and not expected to rise in the future. Fed watchers interpreted that as a sign that officials are at least on the lookout for a change in conditions that could provoke a rate increase.

"They're giving us the parameters they're going to be watching to decide when to start thinking about raising rates," said Alan Levenson, chief economist for T. Rowe Price. "It's not that they're anywhere close to doing so, but it's a subtle and significant preparatory movement."

Winding down

The Fed is moving forward with previously announced plans to wind down its unconventional efforts to prop up the economy, including letting $1.25 trillion in purchases of mortgage backed securities conclude by the end of March 2010.

And Fed policymakers said Wednesday that they will curtail a program to buy $200 billion worth of debt in government-sponsored housing companies such as Fannie Mae and Freddie Mac -- not because they are trying to back away from efforts to support the economy, but because there isn't enough of that debt being issued. Instead of purchasing the full $200 billion in debt, the Fed will wind down its efforts after buying about $175 billion.

After a remarkable two years of aggressive interventions to support the credit markets and the economy, the Fed appears to be entering a more stable period, of waiting to see whether the nascent economic recovery has any legs.

The economy grew at a 3.5 percent annual rate in the third quarter, as measured by gross domestic product, but much of that growth was led by boosts from government policies and business inventory decisions that may not be sustained in future quarters. Moreover, the employment situation remains dire; the Labor Department will report October numbers on Friday, which analysts expect will show that the unemployment rate rose to 9.9 percent and that employers cut another 175,000 jobs.

A nascent recovery

In the statement following their meeting, the Federal Open Market Committed said that "Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit," which matches the view of many private economists.

New data Wednesday supported the idea that the recovery is a fragile one. The Institute for Supply Management said that the service sector expanded at a slower clip in October than in September, with its index of business activity in nonmanufacturing firms falling to 50.3, from 50.6 (numbers above 50 indicate expansion). Even more worrisome, the companies surveyed cut back on their staffing more aggressively in October, as the employment index fell to 41.1 from 44.3.

And ADP, the payroll processing company, said that private employers cut 203,000 jobs in October. That did reflect a slower rate of job losses than the 254,000 shed in September, however.

"The labor market is now at a critical turning point," said Bernard Baumohl, chief global economist of the Economic Outlook Group. "If the economy can't shake off its lethargy and shows just anemic growth, there will be little justification for companies to hire more workers."

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