Break for borrowers as rise in rates ends

Fed's pause at 5.25% eases recession fears


WASHINGTON -- After raising interest rates 17 straight times since June 2004, the Federal Reserve decided yesterday to stop and see whether it has already done enough to keep inflation in check and the economy out of recession.

Its decision means that holders of home-equity loans, adjustable-rate mortgages and credit card debt will be spared higher payments - unless the nation's central bank decides at some point to raise rates again.

It also means there won't be another immediate boost in the prime rate, on which some loans are based, and it could mean that long-term interest rates, such as those on mortgages, no longer will be on the rise and might even fall.

To those worried that another interest-rate increase would send the economy into a recession in the not-too-distant future, the central bank's pause from a long string of interest-rate boosts came as good news.

Experts say the economy is still slowing and that brisk job growth for the rest of the year seems unlikely. Yet, another rate increase could have hastened more layoffs, they said.

"An additional hike would have raised the specter of a recession," said economic consultant Joel Naroff of Holland, Pa.

The National Association of Manufacturers, through its economist, David Huether, said that the Fed's decision will mean that the cost of capital won't be rising and that would help producers continue to invest in new equipment, which would drive the economy higher and possibly create more jobs.

Holding its benchmark federal funds rate - the interest rate banks charge each other for loans - at 5.25 percent, the central bank, headed by Chairman Ben S. Bernanke, concluded that it has tightened enough for the time being, although it acknowledged that "some inflation risks remain."

It counted on the slowing economy - caused in part by the housing slowdown and rising energy prices - to contain rising inflationary pressures.

"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. Bernanke's critics said this is a "dovish" stance that could allow inflation to get out of control.

The stock market, which had been expecting the pause, declined on the news. The big question is whether stock prices will move markedly higher in the future as a result of the decision.

Most analysts interviewed said the pause would benefit the stock market because it signals that the Fed thinks the chances of a recession have decreased.

But some analysts said stocks aren't about to take off as a result of the Fed's pause, a key point of interest to Americans who are invested in equity markets either directly or through retirement funds, such as 401(k) plans at their workplaces.

Michael Drury, an economist at McVean Investment & Trading LLC in Memphis, Tenn., a futures trading firm, said he saw no great surge in stock prices in the near future.

"I think the equity markets have priced in more good news than is available from the Fed," Drury said. Simply by halting its squeeze on the economy, the Fed isn't enabling sharply higher profits to be made on Wall Street, he added.

The move touched off speculation over whether the Fed would raise interest rates again in September, especially if new signs of inflation are not kept in check.

"The extent and timing of any additional firming ... will depend on the evolution of the outlook for both inflation and economic growth," the Fed's policymaking body, the Federal Open Market Committee, said yesterday in a statement.

Market analysts were divided on the question. Some said that inflation is still a big danger that will have to be tackled with at least one more interest-rate increase. Others said the Fed's campaign of interest-rate increases is finished for now.

"A further rate increase at a time when 85 percent of the economy is slowing is just too dangerous," said Bernard Baumohl, executive director of the Economic Outlook Group LLC in New Jersey, citing a high recession risk.

The Federal Open Market Committee, consisting of Fed governors and five of its bank presidents, began raising interest rates when the federal funds rate stood at a 43-year low of 1 percent. It sought to drive interest rates to a "neutral" level, meaning a rate that restrained inflation and let the economy grow at its potential.

Low interest rates triggered a housing boom and caused a number of questionable lending practices. Many Americans took out interest-only loans to buy their homes, and others signed up to adjustable-rate mortgages.

But the housing boom faded as interest rates and energy prices increased. As a result, those who took out adjustable-rate mortgages have seen their monthly payments rise sharply. Drury cited the case of a Memphis hairdresser who complained that her monthly mortgage payments are now $700 higher than when she secured her loan.

David Wyss, chief economist at Standard & Poor's, the credit-rating company, noted that the central bank did not mention a reported slowdown in productivity in the second quarter to 1.1 percent from 4.3 percent in the first quarter. Also, he said, it did not mention that labor costs rose by 3.2 percent in the second quarter after a 2.3 percent gain in the second quarter of 2005.

Wyss said it's clear that the central bankers have cause for concern if it appears that the economy's efficiency is slowing and wages are going up. Such trends could cause more inflation, he said. "That's what they can't afford to let happen," he said.

William Neikirk writes for the Chicago Tribune.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.